will the real market failure please stand up? · chairman schapiro on september 7 ... an unpriced...
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1
Will the Real Market Failure Please Stand Up?
Chairman Schapiro on September 7 • The Flash Crash is “clearly a market failure”
An Internet search produces 767,000 references to market failure • A condition that arises when unrestrained operation of markets yields socially
undesirable results
The story that was (and to some extent still is) being crafted • Market structure itself is the real market failure
Why does the Flash Crash live on? • It has changed the entire tenor of the regulatory debate concerning market structure
and behavior as conditioned by structure • The Flash Crash is used as motivation multiple times in an address by Chairman
Schapiro as late as March 23 of this year
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2
The Flash Crash of May 28
A bad morning
The market drops sharply in the afternoon, then rebounds
Many stocks decline by over nine percent in less than 12 minutes
Full investigation, but the cause remains undetermined
What did market structure look like?
What was the role of market makers, and how did they react?
How did market and stop-loss orders play into the crash?
Speed, speed and more of the same…
Investor behavior and changes in the impact of normal market mechanisms, with an eye towards fair and orderly markets
Price discovery
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3
ETF Volatility
Market Plunge on May 6, 2010: 14:40 -‐ 15:00Average 15 Second Midquote Volatility
0
50
100
150
200
250
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
6-‐May 7-‐May Avg 5/3-‐5/5
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4
Message Traffic Signals
Market Plunge on May 6, 2010: 14:40-‐ 15:00Average 15 Second Buy Limit Order Cancellations / Modifications
0
500
1000
1500
2000
2500
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
Order Cancellatio
ns/M
odificatio
ns
Avg 5/3-‐5/5 6-‐May 7-‐May
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5
What Order Flow Went Along with the Message Traffic?
Market Plunge on May 6, 2010: 14:40 -‐ 15:00 Average 15 Second Number of Fleeting Orders
0
2,000
4,000
6,000
8,000
10,000
12,000
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
Num
ber of Fleeting Orders
Avg 5/3-‐5/5 6-‐May 7-‐May
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A Lagging Indicator of Liquidity Provision
Market Plunge on May 6, 2010: 14:40 -‐ 15:00 Average 15 Second TWA Spread
0
100
200
300
400
500
600
700
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
TWA Spread (in bp
s)
Avg 5/3-‐5/5 6-‐May 7-‐May
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7
ETF Depth at the Top of the Book
Market Plunge on May 6, 2010: 14:40 -‐ 15:00 Average 15 Second Bid Depth Sizes
0
10000
20000
30000
40000
50000
60000
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
Average Bid De
pth Size (in shares)
Avg 5/3-‐5/5 6-‐May 7-‐May
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8
ETF Depth Across Ten Price Levels
Market Plunge on May 6, 2010: 14:40 -‐ 15:00 Average 15 Second TWA Bid Depth Size Up to Level 10
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,00014
:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
Bid De
pth Size Up to Level 10
Avg 5/3-‐5/5 40,304 40,305
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9
S&P 500 Growth Index Fund
IVW Vs. Portfolio: Bid Depth Level 1
0
0.5
1
1.5
2
2.5
3
3.5
4
14:35 14:37 14:39 14:41 14:43 14:45 14:47 14:49 14:51 14:53 14:55 14:57 14:59 15:01 15:03 15:05
Liqu
idut
y - A
sk_D
epth
_Lev
el 1
Pct
Cha
nge
-80
-70
-60
-50
-40
-30
-20
-10
0
Cumulative Return Pct.
Ind IVW Bid_1 Ind Portfolio Bid_1 IVW CumRet Portfolio CumRet
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10
S&P 500 Growth Index Fund
IVW Vs. Portfolio: Bid Depth Level 1-10
0
0.2
0.4
0.6
0.8
1
1.2
1.4
14:35 14:37 14:39 14:41 14:43 14:45 14:47 14:49 14:51 14:53 14:55 14:57 14:59 15:01 15:03 15:05
Liqu
idut
y - A
sk_D
epth
_Lev
el 1
Inde
x Ch
ange
-80
-70
-60
-50
-40
-30
-20
-10
0
Cumulative Return Pct.
Ind IVW Bid_10 Ind Portfolio Bid_10 IVW CumRet Portfolio CumRet
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ETFs with Broken Trades
Affected ETF's Vs. Aggregated Portfolio: Ask Depth Level 1-10
0
0.2
0.4
0.6
0.8
1
1.2
1.4
14:35 14:37 14:39 14:41 14:43 14:45 14:47 14:49 14:51 14:53 14:55 14:57 14:59 15:01 15:03 15:05
Liqu
idity
- Bi
d_De
pth_
Leve
l 1-1
0 In
dex
Cha
nge
-70
-60
-50
-40
-30
-20
-10
0
Cumulative Return Pct.
Indx-AffectedETF's-Ask Depth10 Indx-Affected Portfolio-AskDepth10AffectedETF's-CumRet Affected Portfolio-CumRet
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ETFs without Trade Breaks
Unaffected ETF's Vs. Aggregated Portfolio: Ask Depth Level 1-10
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
14:35 14:37 14:39 14:41 14:43 14:45 14:47 14:49 14:51 14:53 14:55 14:57 14:59 15:01 15:03 15:05
Liqu
idity
- Bi
d_De
pth_
Leve
l 1-1
0 In
dex
Cha
nge
-12
-10
-8
-6
-4
-2
0
Cumulative Return Pct.
Indx-GoodETF-Ask Depth10 Indx-UnAffected Portfolio-AskDepth10 Good ETF-CumRet UnAffected Portfolio-CumRet
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Was the Liquidity Issue Limited to ETFs?
The bulk of the final SEC report is summarized by a few quotes
• “the largest and most erratic price moves were caused by withdrawals of liquidity and the subsequent execution of trades at stub quotes”
• “liquidity had virtually evaporated” (repeated in different contexts)
• “drops in price become increasingly more severe with ever-larger drops in liquidity”
• All in all, “what happened is best described in terms of two liquidity crises—one at the broad index level in the E-Mini, the other with respect to individual stocks”
From market structure to behavior, and onwards to algorithms
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The New Algorithmic Trading Debate
2:32 ET on May 6
An unpriced order was submitted to a volume participation algorithm
35,000 contracts sold as the contract went from 1130 to 1056
Five second pause by the CME
Futures go back to previous level
40,000 more contracts sold
Total elapsed time: 20 minutes
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Volume Participation, Volatility, and Size
0.1
0.5
0.9
1.3
1.7
0.0
2.4
4.8
7.2
9.6
Intraday volatility (%)Relative size (%)
Volume Participation strategy
Strategy-specific cost (bps)
Strategy conditional impact vs. intraday volatility(relative order size set to the mean)
0.1 0.4 0.7 1.0 1.3 1.6 1.9 2.2 2.5 2.8 3.1 3.4 3.7 4.0 4.3 4.6 4.9 5.2
Intraday volatility (%)
Relat
ive co
nditio
nal im
pact
(bps)
ActiveDarkISVWAPVP
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Participation Algorithms for Small Orders
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Participation Algorithms for Large Orders
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If We Have Time for the Regulators…
Regulation of trading strategies Stub Quotes Regulatory Constraints on Brokers Enhanced Data Transparency Circuit Breakers Automated Review Policies
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