H ig h -F r e q u e n c Praise for the book: y High-Frequency t r a “High Frequency Trading offers a much-needed collection of complementary d perspectives on this hottest of topics. The combined academic credentials and in g first-hand market knowledge of the editors is probably unparalleled, and their style of writing precise and engaging. The book is thoughtfully organized, tightly trading focussed in its coverage and comprehensive in its scope. Practitioners, academics and regulators will greatly benefit from this work.” E d RiccaRdo RebonaTo, Global Head of Rates and FX analytics, PiMco, ite and Visiting Lecturer, University of oxford. d B y d “This book is a must read for anyone with any interest in high frequency trading. a New Realities for Traders, The authors of this book are a who’s who of thought leaders and academics vid who literally did the fundamental research in the innovation, development, Markets and Regulators E and oversight of modern electronic trading mechanics and strategies.” a s LaRRy Tabb, Founder & ceo, Tabb Group, and Member of the cFTc le Subcommittee on automated and High Frequency Trading. y, M a r “The concept of high frequency trading too often evinces irrational fears co and opposition.  This book, by experts in the field, unveils the mysteries, s EditEd By david EaslEy, l records the facts and sets out the real pros and cons of such mechanisms.” ó p Marcos lópEz dE prado, cHaRLeS GoodHaRT, Fellow of the british academy, and emeritus Professor e z at the London School of economics. and MaurEEn o’Hara d e p r “Easley, Lopez de Prado, and O’Hara have produced a classic that everyone a d should have on their shelves.” o , aTTiLio MeUcci, chief Risk officer at KKR, and Founder of SyMMyS. a n d M a u r e e n o ’ H a r a PEFC Certified this book has been produced entirely from sustainable papers that are accredited as pEFc compliant. www.pefc.org High Frequency Trading V2.indd 1 09/10/2013 16:34 (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page i — #1 (cid:1) (cid:1) High-Frequency Trading (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page ii — #2 (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page iii — #3 (cid:1) (cid:1) High-Frequency Trading New Realities forTraders,Markets and Regulators Edited by David Easley, Marcos López de Prado and Maureen O’Hara (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page iv — #4 (cid:1) (cid:1) PublishedbyRiskBooks,aDivisionofIncisiveMediaInvestmentsLtd IncisiveMedia 32–34BroadwickStreet LondonW1A2HG Tel:+44(0)2073169000 E-mail:[email protected] Sites:www.riskbooks.com www.incisivemedia.com ©2013IncisiveMediaInvestmentsLimited ISBN978-1-78272-009-6 BritishLibraryCataloguinginPublicationData AcataloguerecordforthisbookisavailablefromtheBritishLibrary Publisher:NickCarver CommissioningEditor:SarahHastings ManagingEditor:LewisO’Sullivan EditorialDevelopment:SarahHastings Designer:LisaLing Copy-editedandtypesetbyT&TProductionsLtd,London PrintedandboundintheUKbyBerfortsGroup Conditionsofsale Allrightsreserved.Nopartofthispublicationmaybereproducedinanymaterialformwhether byphotocopyingorstoringinanymediumbyelectronicmeanswhetherornottransiently orincidentallytosomeotheruseforthispublicationwithoutthepriorwrittenconsentof thecopyrightownerexceptinaccordancewiththeprovisionsoftheCopyright,Designsand PatentsAct1988orunderthetermsofalicenceissuedbytheCopyrightLicensingAgency LimitedofSaffronHouse,6–10KirbyStreet,LondonEC1N8TS,UK. Warning:thedoingofanyunauthorisedactinrelationtothisworkmayresultinbothcivil andcriminalliability. Everyefforthasbeenmadetoensuretheaccuracyofthetextatthetimeofpublication,this includeseffortstocontacteachauthortoensuretheaccuracyoftheirdetailsatpublication iscorrect.However,noresponsibilityforlossoccasionedtoanypersonactingorrefraining fromactingasaresultofthematerialcontainedinthispublicationwillbeacceptedbythe copyrightowner,theeditor,theauthorsorIncisiveMedia. Manyoftheproductnamescontainedinthispublicationareregisteredtrademarks,andRisk Bookshasmadeeveryefforttoprintthemwiththecapitalisationandpunctuationusedbythe trademarkowner.Forreasonsoftextualclarity,itisnotourhousestyletousesymbolssuch asTM,®,etc.However,theabsenceofsuchsymbolsshouldnotbetakentoindicateabsence oftrademarkprotection;anyonewishingtouseproductnamesinthepublicdomainshould firstclearsuchusewiththeproductowner. Whilebesteffortshavebeenintendedforthepreparationofthisbook,neitherthepublisher, theeditornoranyofthepotentiallyimplicitlyaffiliatedorganisationsacceptresponsibility foranyerrors,mistakesandoromissionsitmayprovideorforanylosseshowsoeverarising fromorinrelianceuponitsinformation,meaningsandinterpretationsbyanyparties. (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page v — #5 (cid:1) (cid:1) Contents AbouttheEditors vii AbouttheAuthors ix Preface xv 1 TheVolumeClock:InsightsintotheHigh-FrequencyParadigm 1 DavidEasley;MarcosLópezdePrado;MaureenO’Hara CornellUniversity;RCCatHarvardUniversity; CornellUniversity 2 ExecutionStrategiesinEquityMarkets 21 MichaelG.Sotiropoulos BankofAmericaMerrillLynch 3 ExecutionStrategiesinFixedIncomeMarkets 43 RobertAlmgren QuantitativeBrokersLLC;NewYorkUniversityCourant InstituteofMathematicalSciences 4 High-FrequencyTradinginFXMarkets 65 AntonGolub,AlexandreDupuis,RichardB.Olsen OlsenLtd 5 MachineLearningforMarketMicrostructureand High-FrequencyTrading 91 MichaelKearnsandYuriyNevmyvaka UniversityofPennsylvania 6 A“BigData”StudyofMicrostructuralVolatilityin FuturesMarkets 125 KeshengWu,E.WesBethel,MingGu,DavidLeinweber,OliverRübel LawrenceBerkeleyNationalLaboratory 7 LiquidityandToxicityContagion 143 DavidEasley;MarcosLópezdePrado;MaureenO’Hara CornellUniversity;RCCatHarvardUniversity; CornellUniversity 8 DoAlgorithmicExecutionsLeakInformation? 159 GeorgeSofianos,JuanJuanXiang GoldmanSachsEquityExecutionStrats v (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page vi — #6 (cid:1) (cid:1) HIGH-FREQUENCYTRADING 9 ImplementationShortfallwithTransitoryPriceEffects 185 TerrenceHendershott;CharlesM.Jones;AlbertJ.Menkveld UniversityofCalifornia,Berkeley;ColumbiaBusinessSchool; VUUniversityAmsterdam 10 TheRegulatoryChallengeofHigh-FrequencyMarkets 207 OliverLinton;MaureenO’Hara;J.P.Zigrand UniversityofCambridge;CornellUniversity;LondonSchoolof EconomicsandPoliticalScience Index 231 vi (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page vii — #7 (cid:1) (cid:1) About the Editors DavidEasleyistheHenryScarboroughprofessorofsocialscience, professorofeconomicsandprofessorofinformationscienceatCor- nellUniversity.HeservedaschairoftheCornelleconomicsdepart- mentfrom1987to1993and2010to2012.HeisafellowoftheEcono- metric Society and has served as an associate editor of numerous economicsjournals.Davidrecentlyco-authoredthebookNetworks, CrowdsandMarkets:ReasoningAboutaHighlyConnectedWorld,which combines scientific perspectives from economics, computing and informationscience,sociologyandappliedmathematicstodescribe theemergingfieldofnetworkscience. MarcosLópezdePradoisheadofquantitativetradingandresearch atHETCO,thetradingarmofHessCorporation,aFortune100com- pany. Previously, Marcos was head of global quantitative research atTudorInvestmentCorporation,wherehealsoledhigh-frequency futurestrading.Inadditiontomorethan15yearsofinvestmentman- agementexperience,Marcoshasreceivedseveralacademicappoint- ments, including postdoctoral research fellow of RCC at Harvard University,visitingscholaratCornellUniversity,andresearchaffil- iateatLawrenceBerkeleyNationalLaboratory(USDepartmentof Energy’sOfficeofScience).Marcosholdstwodoctoratedegreesfrom Complutense University, is a recipient of the National Award for Excellence in Academic Performance (Government of Spain), and wasadmittedintoAmericanMensawithaperfecttestscore. MaureenO’HaraistheRobertW.Purcellprofessoroffinanceatthe JohnsonGraduateSchoolofManagement,CornellUniversity.Her researchfocusesonmarketmicrostructure,andsheistheauthorof numerousjournalarticlesaswellasthebookMarketMicrostructure Theory.Maureenservesonseveralcorporateboards,andischairman oftheboardofITG,aglobalagencybrokeragefirm.Sheisamem- ber of the CFTC-SEC Emerging Regulatory Issues Task Force (the “flashcrash”committee),theGlobalAdvisoryBoardoftheSecuri- tiesExchangeBoardofIndia(SEBI)andtheAdvisoryBoardofthe OfficeofFinancialResearch,USTreasury. vii (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page viii — #8 (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) (cid:1) “Easley” — 2013/10/8 — 11:31 — page ix — #9 (cid:1) (cid:1) About the Authors RobertAlmgrenisaco-founderofQuantitativeBrokers,whichpro- videsagencyalgorithmicexecutionandcostmeasurementininterest ratemarkets.HeisaFellowinthemathematicsinfinanceprogram atNewYorkUniversity.Until2008,Robertwasamanagingdirector andheadofquantitativestrategiesintheelectronictradingservices group of Banc of America Securities. From 2000 to 2005 he was a tenuredassociateprofessorofmathematicsandcomputerscienceat theUniversityofToronto,anddirectorofitsMasterofMathemati- calFinanceprogram.Hehasanextensiveresearchrecordinapplied mathematics,includingpapersonoptimaltrading,transactioncost measurementandportfolioconstruction. E. Wes Bethel is a senior computer scientist at Lawrence Berkeley National Laboratory, where he conducts and manages research in the area of high performance visualisation and analysis. He is a member of IEEE and a Distinguished Scientist of the Association forComputingMachinery.HehasaPhDincomputersciencefrom theUniversityofCalifornia,Davis. AlexandreDupuishasworkedatOLSENsince2006andisheadof thequantitativeresearchunitRomandy.Hisfocusliesinresearching anddevelopingtradingmodelsaswellascreatingrisk-management tools. Alex is a member of the risk-management team where he controls a third of the investment portfolio. In collaboration with universities,hesupervisesPhDstudentsinthefieldofquantitative finance.AlexholdsaPhDincomputersciencefromtheUniversity of Geneva and has gained further research experience by working attheUniversityofOxfordandatETH. Anton Golub has worked at OLSEN since the summer of 2012 as a member of the research team. He performs research in the field of market micro-structure, leveraging the methodology developed at OLSEN. Anton previously worked at the Manchester Business School as a researcher on high-frequency trading, market micro- structure and flash crashes. In 2012, he was invited to participate in an international project on computerised trading funded by the ix (cid:1) (cid:1) (cid:1) (cid:1)