High Frequency Trading. Economic Necessity or Threat to the Economy?
(Sprache: Englisch)
In the last four decades, technological progress led to an electrification of stock tra ding systems. It was realized that the profitability of trading strategies could be increased by employing computer algorithms to trade autonomously. This led to the...
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In the last four decades, technological progress led to an electrification of stock tra ding systems. It was realized that the profitability of trading strategies could be increased by employing computer algorithms to trade autonomously. This led to the implementation of High Frequency Trading (HFT). Theoretically HFT should increase efficiency in financial markets but it seems that, at least under certain circumstances, it causes market instability. The aim of this paper is to discuss the effect of HFT on market quality and why HFT cannot be fully explained by the neoclassical theory of economics. Therefore, the controversial positions in literature will be presented and discussed. It is especially referred to the influence of HFT on liquidity, price discovery and volatility. Primarily, its negative effect on volatility seems to contravene the modern finance. Furthermore, in the course of this work it will be illustrated that, by employing strict regulation of financial markets, this negative impact cannot be reduced to a suf ficient extent in order for HFT to be characterized as market optimizing, accor ding to the neoclassical theory of economics.
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Text Sample:Chapter 1., Introduction:
1.1 Problem:
In the last four decades, technological progress led to an electrification of stock tra-ding systems. Traders were enabled to place their orders, which were later pro-cessed via electronic networks, with the help of computers. Soon they realized that the profitability of trading strategies could be increased by employing computer algo-rithms to trade autonomously, reducing time needed to analyze information, publish quotes as well as trigger and process trades. This led to the implementation of Algo-rithmic Trading (AT). High Frequency Trading (HFT) is a subset of AT, at which fi-nancial instruments are traded by algorithms at very high speed.
The past has shown that negative developments on capital markets are intensified by HFT. Andrei Kirilenko explains in his work The Flash Crash: The Impact of High Frequency Trading on an Electronic Market that HFT did not trigger the Flash Crash but intensified the volatility that resulted from the event. Also on the 19th of October 1987, Black Monday , the increasing compu terization of stock trading processes led to a signi ficant price drop. As a consequence, the high and still growing market share of HFT leads to an increase in risk that a simple correction turns into a serious drop in prices causing market instability. Theoretically HFT should increase efficiency in financial markets. However, due to the empirical observation mentioned above, it seems that HFT takes effect the other way round. It seems that, at least under certain circumstances, HFT enlarges volatility. This cannot be explained by the econo mic neoclassical theory. This problem is discussed in a lot of literature in which se veral different approaches have been made to explain it.
1.2 Aim:
The aim of this paper is to discuss why HFT cannot be fully explained by the neo-classical theory of economics. Therefore, the controversial positions in literature will be presented and discussed.
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Primarily, its negative influence on volatility seems to contravene the modern finance. Furthermore, in the course of this work it will be illustrated that, by employing strict regulation of financial markets, this negative impact cannot be reduced to a suf ficient extent in order for HFT to be characterized as market optimizing, accor ding to the neoclassical theory of economics.
1.3 Research Questions:
As a result of this objective, the following research questions arise:
1) Is there research that perfectly describes the effect of HFT on capital mar-kets or is it, based on a comparison of different researchers findings, ne-cessary to combine these findings in order to ensure a realistic description of the matter?
2) Can the negative effect of HFT on market quality be reduced, by employing strict regulation of financial markets, to a sufficient extent in order for HFT to be explained by the neoclassical theory of economics?
1.4 Scientific Method:
The scientific method is comprised of literature research. For this paper mainly wor-king papers and professional articles have been used as references.
1.5 Structure of the paper:
In the first part of this study, the basics of HFT are explained, with reference to its history, the presence of HFT in current markets as well as its users and their strate-gies.The following chapter deals with the effect of HFT on capital markets and its capabi-lity of optimizing financial markets according to the neoclassical theory of economics. Findings on the effect of HFT on liquidity, price discovery and volatility in financial markets are examined.
The importance of regulation and supervision of HFT as well as regulatory measures and their influence on market quality are topics of the third section of this paper. Also, the Flash Crash of May 06, 2010 , an incident impelling the regulation of HFT, is illustrated in detail. A conclusion is shown in the last part of the paper.
1.3 Research Questions:
As a result of this objective, the following research questions arise:
1) Is there research that perfectly describes the effect of HFT on capital mar-kets or is it, based on a comparison of different researchers findings, ne-cessary to combine these findings in order to ensure a realistic description of the matter?
2) Can the negative effect of HFT on market quality be reduced, by employing strict regulation of financial markets, to a sufficient extent in order for HFT to be explained by the neoclassical theory of economics?
1.4 Scientific Method:
The scientific method is comprised of literature research. For this paper mainly wor-king papers and professional articles have been used as references.
1.5 Structure of the paper:
In the first part of this study, the basics of HFT are explained, with reference to its history, the presence of HFT in current markets as well as its users and their strate-gies.The following chapter deals with the effect of HFT on capital markets and its capabi-lity of optimizing financial markets according to the neoclassical theory of economics. Findings on the effect of HFT on liquidity, price discovery and volatility in financial markets are examined.
The importance of regulation and supervision of HFT as well as regulatory measures and their influence on market quality are topics of the third section of this paper. Also, the Flash Crash of May 06, 2010 , an incident impelling the regulation of HFT, is illustrated in detail. A conclusion is shown in the last part of the paper.
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Bibliographische Angaben
- Autor: Stefan Höppel
- 2014, Erstauflage, 48 Seiten, Maße: 15,5 x 22 cm, Kartoniert (TB), Englisch
- Verlag: Anchor Academic Publishing
- ISBN-10: 3954892197
- ISBN-13: 9783954892198
Sprache:
Englisch
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