Preview of Activities

Quiz

This assessment will count towards your individual participation grade

Session 5

Innovative Market Structures

At the end of this week, you will be able to:

  1. Explain the advantages and disadvantages of speed bumps.
  2. Weigh the advantages and risks of dark liquidity.
  3. Compare the key features that distinguish dark markets from lit exchanges.
  4. Evaluate when a dark market would be preferred over a lit market for a particular client, asset, or situation.



Speed Bumps

A ‘speed bump’ is a mechanism for slowing down fast traders in order to give slower traders a fairer chance at the market. By implementing a timed delay (usually milliseconds) between the receipt of an order and the execution of its instructions, speed bumps are intended to mitigate the effects of asymmetric information by reducing the speed advantage of fast, sophisticated traders - such as predatory high-frequency traders (IIROC, 2018). However, critics of the mechanism (including many electronic trading firms) attest that speed bumps may make markets unnecessarily complex and unfairly favor certain market participants (Osipovich, 2019). Despite these concerns, nearly a dozen exchanges have proposed or implemented speed bumps. While the design of speed bumps differs across exchanges, all speed bumps in operation (except for IEX, which employs a “symmetrical” speed bump across all but pegged orders) are random and asymmetric, meaning that only liquidity-taking order types are delayed (Aoyagi, 2020).


References

  1. Aoygi, J. (2020, July 30). The Optimal Speed to Go over Speed Bumps in Financial Markets. Retrieved on August 31, 2020 from https://www.researchgate.net/publication/330132515_The_Dark_Side_of_Regulating_Fast_Informed_Trading
  2. Investment Industry Regulatory Organization of Canada (IIROC). (2018, January 28). Speed Segmentation on exchanges: competition for slow flow. Retrieved on August 21, 2020 from https://www.iiroc.ca/Documents/2018/25d5b306-3420-43cc-b260-a1527b82bfc3_en.pdf
  3. Osipovich, A. (2019, July 29). More Exchanges Add ‘Speed Bumps,’ Defying High-Frequency Traders. The Wall Street Journal. Retrieved on August 31, 2020 from https://www.wsj.com/articles/more-exchanges-add-speed-bumps-defying-high-frequency-traders-11564401611

Watch the following videos

 

Speed Bumps

Mandatory Readings

While some exchanges have readily adopted speed bumps and other speed-control measures, the question remains - are slower markets better? As you read through the following articles, consider whether you feel that exchanges should have a role in controlling the speed of their trading participants.

  1. Physics in finance: Trading at the speed of light

Buchanan, M. (2015, February 11). Physics in finance: Trading at the speed of light. Nature, 518(7538). Retrieved on August 29, 2020 from https://www.nature.com/news/physics-in-finance-trading-at-the-speed-of-light-1.16872 2.

Virtual speed bump for lightning-fast markets proposed

University of British Columbia - Sauder School of Business. (2019, October 29). Virtual speed bump for lightning-fast markets proposed. ScienceDaily. Retrieved August 31, 2020 from www.sciencedaily.com/releases/2019/10/191029140714.htm 3.

Asymmetric speed bumps: A market design response to high-frequency trading

Baldauf, M. & Mollner, J. (2019, October 31). Asymmetric speed bumps: A market design response to high-frequency trading. Retrieved on August 21, 2020 from https://voxeu.org/article/asymmetric-speed-bumps-response-high-frequency-trading

Speed Bumps

Check Your Understanding

Q: Do you think that speed bumps are an effective form of regulation? Why or why not? Consider whether or not you think that HFTs could bypass them.



Dark Markets

“Darkness” refers to a lack of pre-trade quote transparency - neither the buyer nor the seller posts a visible bid or ask (Hasbrouck, 2017). Dark pools are alternative trading systems in which dark trades of securities and other financial instruments take place; these marketplaces are frequently used by large block traders (such as exchanges and institutional investors) who wish to trade without revealing information pre-trade that may cause markets to move against them (Aguilar 2015). Dark markets function in contrast to ‘lit’ markets; in lit markets, pre-trade bid and ask quotes are publicly displayed. Examples of lit markets include national exchanges, such as the New York Stock Exchange and the Nasdaq, and other traditional pools of liquidity.


References

  1. Aguilar, L. (2015, November 18). Shedding Light on Dark Pools. Retrieved on August 17, 2020 from https://www.sec.gov/news/statement/shedding-light-on-dark-pools.html
  2. Hasbrouck, J. (2017, June 21). Securities Trading: Principles and Procedures. Chapter 8: Dark Markets. Retrieved on August 31, 2020 from http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPms12a.pdf

Dark Markets

Mandatory Readings

As you read through the articles below, think about the distinguishing features of dark pools and why they have been reported as a “haven for predatory high-frequency traders.”

  1. Shedding Light on Dark Pools

Aguilar, L. (2015, November 18). Shedding Light on Dark Pools. Retrieved on August 17, 2020 from https://www.sec.gov/news/statement/shedding-light-on-dark-pools.html 2.

Chapter 8: Dark Markets (pages 62-66)

Hasbrouck, J. (2017, June 21). Securities Trading: Principles and Procedures. Retrieved on August 17, 2020 from http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPms12a.pdf

Dark Markets

Check Your Understanding

Q1: Which three of the following six features/statements are associated with dark markets? Which three are associated with lit markets?

  1. In this type of market, buyers and sellers post visible bids and asks.
  2. Attracting sufficient liquidity has often been a problem in this type of market.
  3. The New York Stock Exchange is an example of this type of market.
  4. The prices established in this type of market are often relied upon by the other type.
  5. Participants in these markets often lack crucial information about how their trading systems function—and about the serious conflicts of interest they can harbor.
  6. In this type of market, market impact is significantly reduced for large orders.

Q2: You are participating in the market as an individual, slow investor (you are not supported by the sophisticated trading technology used by high-frequency trading firms). Would you prefer to participate in:

  1. A dark market or a lit market? Why?
  2. In a market with speed bumps or without speed bumps? Why?

Q3: In your own words, explain why dark pools have been reported as a “haven for predatory high-frequency traders”.



Deliverables

.js-id-session5

Session 5 Quiz

This quiz will count towards your individual participation grade. Ensure you have completed all mandatory readings before starting the quiz (they will be tested). Only entries submitted prior to the beginning of next class will be accepted. Please note that these quizzes are being assessed on a participation basis only; full marks will be given to those that complete the quiz (scores will not affect the participation grade).
Session 5 Quiz