Trading Dynamics in a Fragmented Market

<p>In this dissertation, we study the effect of recent regulatory and technological changes on trading</p> <p>dynamics. Advances in communication and computing technologies have made millisecond</p> <p>latencies as the new trading standard and have resulted in a new era of automated trading. The</p> <p>introduction of Reg-NMS (Regulation National Market System, implemented in 2007) has set</p> <p>strict rules for the access and removal of liquidity from the fragmented US equity market, de</p> <p>facto linking the trading activities across trading venues. These transformations have not only</p> <p>changed how equity markets function but also how market participants interact with the market</p> <p>and among themselves.</p> <p>We begin this study by examining how the introduction of Reg-NMS has affected the trading</p> <p>strategies of fast, impatient traders. The implementation of Rule 611, which extends price priority</p> <p>across all the trading venues in the National Market System, forces them to monitor all trading</p> <p>venues in order to correctly asses the placement of their orders. We find evidence that because</p> <p>of their impatient nature, these traders react to all events that negatively affect the position of</p> <p>their orders, regardless of the venue of origin. This behavior results in an order flow that is made</p> <p>up of a high volume of very short-lived limit orders, which is consistent with a previously studied,</p> <p>but not yet fully explained, phenomenon of fleeting liquidity.</p> <p>II</p> <p>We then investigate whether fast, impatient traders are able to leverage their speed advantage</p> <p>to turn market fragmentation in their favor. We find evidence that their ability to anticipate the</p> <p>order flow of the other market participants, allows them to engage in a trading strategy that</p> <p>relies on the simultaneous submission of multiple orders across exchanges. Such strategy, called</p> <p>Overbooking, aims at executing only one of these orders rather than all of them and uses the</p> <p>availability of multiple exchanges to increase the probability of execution while limiting the risk</p> <p>of over execution thanks to their speed advantage.</p> <p>Overall, our findings show that a sub group of traders was not only able to adapt to a changing</p> <p>trading environment but actually take advantage of it. The Overbooking trading strategy is</p> <p>effective at increasing the probability of execution while also decreasing execution time and it is</p> <p>particularly effective for stocks with a high degree of competition for superior queue placement.</p> <p>This suggests that the ability to effectively trade on multiple venues simultaneously allows fast,</p> <p>impatient traders to avoid engaging in a costly algorithmic battle for a favorable queue</p> <p>placement, or submitting very aggressively priced limit orders, to attain quick execution.</p> <p>Moreover, our findings show that the actions of these traders, driven by their fast, and impatient</p> <p>nature and constrained by the complex rules that regulate liquidity access and provision on the</p> <p>National Market System, result in the linking of order flow dynamics across trading venues. We</p> <p>find that the cancellation of an order can be determined by changes that have occurred</p> <p>elsewhere in the market and that to model correctly order flow dynamics it is necessary to</p> <p>include in the analysis the changes that occur on all trading venues. We also find that fast,</p> <p>impatient traders, actively monitor the state of all trading venues after order submission, and</p> <p>that they benchmark the present state of the market to the state at submission.</p>

Name thesis:degree_name

Doctor of Philosophy (PhD)

Level thesis:degree_level

Dissertation

Discipline thesis:degree_discipline

Finance

Year

2017

Author dc:creator

• Herman, Krzysztof

Contributors dc:contributor

• Raja Velu

• algorithmic trading
• Market fragmentation
• market microstructure
• Business

Repository record dc:identifier

https://surface.syr.edu/etd/726

OAI identifier oai:identifier

oai:surface.syr.edu:etd-1726