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This Is Gonna be Good


Linette Lopez, BI, New York Attorney General Endorses A Radical Change To The Way The World Trades Stocks, here. Don’t the digital ad folks run auctions every 10 or 20 millis? This reeks of Uncle Remus ” please, please, please, don’t throw me in the briar patch.”

To his credit, Schneiderman went to war armed with at least one strong suggestion — one that could drive exchanges completely up a wall.

“[S]tock exchanges as well as the Securities and Exchange Commission and other regulators should review the feasibility of the recommendations recently put forward by economists at the University of Chicago School of Business – an institution renowned for its commitment to free markets,” Schneiderman said Tuesday.

The recommendations he refers to are actually a radical new way to match stock buyers with sellers called “frequent batch auctions.” Professors Eric Budish, Peter Cramton, and John Shim laid it out in a paper titled “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response” [PDF] in Decemeber.

Instead of trading stocks constantly throughout the day, with this method exchanges would sell them in auctions at intervals, such as once per second or once every tenth of a second.

Traders would not be able to see the prices at each auction; rather, the exchanges would collect the orders at the time of auction and execute them where bids match offers, thus consistently finding the right price without manipulation, according to the professors.

I read somewhere that robots are really good now at the rock-scissors-paper game.

Budish, Cramton, and Shim, The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response, here.

We argue that the continuous limit order book is a flawed market design and propose that financial exchanges instead use frequent batch auctions: uniform-price sealed-bid double auctions conducted at frequent but discrete time intervals, e.g., every 1 second. Our argument has four parts. First, we use millisecond-level direct-feed data from exchanges to show that the continuous limit order book market design does not really “work” in continuous time: market correlations completely break down at high-frequency time horizons. Second, we show that this correlation breakdown creates frequent technical arbitrage opportunities, available to whomever is fastest, which in turn creates an arms race to exploit such opportunities. Third, we develop a simple new theory model motivated by these empirical facts. The model shows that the arms race is not only socially wasteful – a prisoner’s dilemma built directly into the market design – but moreover that its cost is ultimately borne by investors via wider spreads and thinner markets. Last, we show that frequent batch auctions eliminate the arms race, both because they reduce the value of tiny speed advantages and because they transform competition on speed into competition on price. Consequently, frequent batch auctions lead to narrower spreads, deeper markets, and increased social welfare.


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