SOURCE: Capital Markets Cooperative Research Centre

Capital Markets Cooperative Research Centre

August 13, 2012 21:00 ET

New Research Busts High-Frequency Trading and Dark Pool Myths -- CMCRC

BEIJING--(Marketwire - Aug 13, 2012) - Capital Markets Cooperative Research Centre (CMCRC), the Australian independent academic centre for capital market research, has found that high-frequency trading (HFT) actually benefits capital market structures and performance, while dark pools may have damaging effects.

Speaking at an event in Beijing, Professor Frino outlined his research that showed that HFT activity adds real liquidity to markets and has no impact on price volatility -- surprising findings, as HFT has regularly been accused of negatively impacting these measures of market quality.

"High frequency traders now account for more than 50 percent of trading volume in some global markets, whereas seven years ago it was virtually absent from markets," Professor Frino said. "Alongside this trend is an explosion in so-called 'dark pools,' in which investors are executing their trading in invisible or non-transparent markets. Dark pools are making trading on exchanges less relevant."

Professor Frino also spoke about his new research, released last month, indicating that dark liquidity could damage market quality and increase trading costs in certain markets.

Professor Frino designed a mathematical model (an econometric time-series model) that demonstrates the impacts on lit markets when trading moves into dark pools, showing how bid-ask spreads change relative to volume. Designed for the Australian market, it is also applicable to other small markets with fast trading technology, such as Canada and Singapore.

In a two-year HFT project, researchers examined detailed market data provided by the SGX; NASDAQ; Euronext Paris, ASX and LSE. The team looked at the impact of HFT on liquidity provision and volatility, and were surprised by the results.

"Last year at the beginning of the project I spoke extensively to buy-side around the world to gather their views on HFT," said Professor Frino. "Those views were fairly negative, so I expected to find negative effects, but to my surprise that wasn't the case at all."

While HFT liquidity has been described as 'artificial,' Professor Frino's research found that the liquidity they provide is both real and substantial. "We looked at 'make' and 'take' decisions of HFTs, that is, how often they offer a quote that is hit, and how often they hit existing quotes," he said. "We found that overall they are net providers of liquidity -- and this liquidity is as readily used by other market participants as any other kind."

Professor Frino's research also examined the relationship between price volatility and HFT. "We find no evidence of a positive relationship between HFT and price volatility. To the contrary the data suggests that rather than exacerbating price volatility as many have claimed, HFTs may actually play a role in decreasing excessive price volatility," he said. "Part of this function is the way HFT algorithms identify trading opportunities -- they're built to recognise when prices are abnormally high or low, and their response to this naturally pushes prices back towards equilibrium."

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The Capital Markets Cooperative Research Centre was formed in 2001 to bring together the best in innovative research and technology to the capital markets domain. It is the initiative of a group of researchers, Universities and industry partners who have an impressive track record of commercial success. It attracts the best of Australia's researchers to work together with industry partners to develop new and innovative technologies for the capital markets domain.

Alex Frino is CEO of Capital Markets Co-operative Research Centre (CMCRC) and Professor of Finance at the University of Sydney. He has a PhD in Finance from the University of Sydney and a Master of Philosophy in Finance from Cambridge University.

Alex has strong links with both capital markets industry and academia in Australia and internationally and is a major advocate and motivator for closer collaboration between the two.

Alex has published more than 100 research papers and one book and he has held visiting appointments at the Sydney Futures Exchange and Credit Suisse First Boston. He is a Certified Practising Accountant and serves on the Disciplinary Tribunal of the Australian Securities Exchange.

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