Professor Michael Aitken, CMCRC chief executive

HFT improves market fairness, says CMCRC

The presence of high-frequency traders improves market fairness by reducing end-of-day price dislocation, according to research from the Capital Markets Cooperative Research Centre (CMCRC).

Professor Michael Aitken (pictured), CMCRC chief executive, says that end of day (EOD) price dislocations whether they occurred by fair means or foul were troublesome for markets and that any market structure change which mitigates the incidence of such changes should be seen as a positive outcomes for the marketplace.
 
“EOD prices are often used to determine the expiration value of directors’ options, the price of seasoned equity issues, evaluate broker performance, calculate net asset values of mutual funds, and compute stock indices,” he says. “So on the one hand there’s clear incentive to manipulate the closing price by ramping end of day trading to push the closing price to an artificial level. However, EOD dislocation could also simply reflect price pressure brought on by the fact that the market is about to close for 18 hours. Either way, EOD dislocation of prices is not a good look for markets.”
 
The authors - Professor Douglas Cumming, Professor and Ontario Research Chair at York University - Schulich School of Business, Feng Zhan, York University - Schulich School of Business and Professor Aitken – examined data from 22 exchanges from around the world, from 2003-2011.
 
They found that the presence of HFT decreases the probability of end-of-day (EOD) dislocation by 21 per cent. Moreover, they found that HFT was associated with a decrease in the total trading value surrounding each suspected dislocation, by the most conservative estimate of 42 per cent relative to the average size of the total trading value, suggesting that the mere presence of HFT participants in a marketplace may discourage EOD dislocation.  
 
The study also examined specific dates when EOD price dislocation was most likely to be manipulation, including dates when options expire and end of month/quarter calendar dates. The data showed that in the presence of HFT, EOD price dislocation was less pronounced on these dates as well.
 
Aitken says that market participants and regulators had been concerned for some time about the potentially adverse role HFTs could be playing in markets. HFT has become commonplace in many exchanges around the world, and estimates vary due to the difficulty in ascertaining data, HFT probably accounts for 50-70 per cent of equity trades in the US, 40 per cent in Canada, and 35 per cent in London. The authors examined the robustness of their findings to different proxies to identify the material presence of HFT in a marketplace, including trade size, cancellation of orders, and co-location.
 
Professor Aitken says that policy mechanisms, including trading rules, surveillance and enforcement, appeared to have had less of an effect in mitigating EOD price dislocation than HFT, suggesting that the market may indeed be capable of disciplining itself.
 
“There is an established negative relationship between liquidity and EOD prices (i.e. the higher the liquidity the harder it is to manipulate or the less prices will move) and that HFT by either providing additional liquidity at these points (or because market participants know that HFT are present in a marketplace) appears to reduce EOD dislocation, whether it is caused by fair means or foul,” he says.

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