Prof.Cramton, Co-Authors Honored for Research on High-Frequency Trading

The College of Behavioral and Social Sciences congratulates Professor Peter Cramton of the Department of Economics, who—together with co-authors Associate Professor Eric Budish and Ph.D. student John J. Shim of the University of Chicago Booth School of Business—received the prestigious 2014 AQR Insight Award for innovative research on high-frequency trading. Sponsored by AQR Capital Management, the award recognizes “important, unpublished papers that provide the most significant, new practical insights” for investors.

Budish, Cramton and Shim received the award for what AQR describes as their “path-breaking” paper, “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response.” The research recently was praised in a speech by New York Attorney General Eric T. Schneiderman as “a detailed and thoughtful proposal for reforms that would fundamentally reorient the markets in a very simple way that would help restore confidence in them. Their proposals would reaffirm the basic concept that the best price—not the highest speed—should win.”

“We are honored by the award and are excited by the research that lies ahead,” Professor Cramton said. “Improving well-established markets is no easy task. There is much work that remains to be done.”

In the paper, the authors argue that current financial market structure—based on continuous trading—creates an arms race for speed. Traders and exchanges spend billions of dollars to shave ever-smaller fractions of a second from trading times. In the continuous market, the fastest trader is able to pick off stale quotes, profiting at the expense of the trader providing liquidity. The result is a never-ending arms race for speed that is wasteful and harms liquidity.

The authors propose to replace continuous trading with “frequent batch auctions”—auctions at predetermined time intervals, such as once every second. The auctions would stop the arms race and enhance liquidity by transforming competition on speed into competition on price.

“Our research points to a fundamental flaw in the design of financial markets,” says Cramton. “The root of the problem is not evil high-frequency traders; it’s continuous-time trading. Continuous trading breeds constant change and heightened complexity, making markets vulnerable to instability. Trading at discrete intervals, such as once per second, simplifies markets and allows both traders and exchanges to focus on improvements that make trading smarter and safer.”

The paper recently was presented to U.S. regulators at the Security and Exchange Commission, the Commodity Futures Trading Commission and the Financial Industry Regulatory Authority. The paper also was featured in a report of the European Commission on financial market stability.

Published on Fri, May 30, 2014 - 11:45AM