Real-time risk : what investors should know about FinTech, high-frequency trading, and flash crashes

214 Pages·2017·4.417 MB·English

by  Aldridge, Irene, Krawciw, Steven

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Real-Time Risk
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Real-Time Risk
What Investors Should Know About
FinTech, High-Frequency Trading,
and Flash Crashes
IRENE ALDRIDGE AND
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STEVE KRAWCIW
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Copyright©2017byIreneAldridgeandSteveKrawciw.Allrightsreserved.
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To Henry and Rosalind
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Contents
Acknowledgments xi
CHAPTER1
SiliconValleyIsComing! 1
EveryoneIsintoFintech 3
TheMillennialsAreComing 7
SocialMedia 9
Mobile 10
CheaperandFasterTechnology 13
CloudComputing 14
Blockchain 15
FastAnalytics 15
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IntheEnd,It’sAllAboutReal-TimeDataAnalytics 18
EndofChapterQuestions 19
CHAPTER2
ThisAin’tYourGrandma’sData 21
Data 21
TheRiskofData 23
Technology 27
Blockchain 30
WhatElementsAreCommontoAllBlockchains? 31
Conclusions 39
EndofChapterQuestions 39
CHAPTER3
DarkPools,Exchanges,andMarketStructure 41
TheNewMarketHours 51
WhereDoMyOrdersGo? 52
ExecutingLargeOrders 54
TransactionCostsandTransparency 56
Conclusions 57
EndofChapterQuestions 57
vii
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viii CONTENTS
CHAPTER4
WhoIsFront-RunningYou? 59
Spoofing,FlakyLiquidity,andHFT 64
Order-BasedNegotiations 78
Conclusions 80
EndofChapterQuestions 81
CHAPTER5
High-FrequencyTradinginYourBackyard 83
ImplicationsofAggressiveHFT 89
AggressiveHigh-FrequencyTradinginEquities 96
AggressiveHFTinUSTreasuries 98
AggressiveHFTinCommodities 99
AggressiveHFTinForeignExchange 101
Conclusions 102
EndofChapterQuestions 102
CHAPTER6
FlashCrashes 103
WhatHappensDuringFlashCrashes? 104
(cid:2) DetectingFlash-CrashProneMarketConditions 116 (cid:2)
AreHFTsResponsibleforFlashCrashes? 124
Conclusions 126
EndofChapterQuestions 127
CHAPTER7
TheAnalysisofNews 129
TheDeliveryofNews 130
PreannouncementRisk 139
Data,Methodology,andHypotheses 143
Conclusions 154
EndofChapterQuestions 154
CHAPTER8
SocialMediaandtheInternetofThings 155
SocialMediaandNews 160
TheInternetofThings 165
Conclusions 169
EndofChapterQuestions 170
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Contents ix
CHAPTER9
MarketVolatilityintheAgeofFintech 171
TooMuchData,TooLittleTime—Welcome,Predictive
Analytics 174
WanttoLessenVolatilityofFinancialMarkets?Express
YourThoughtsOnline! 175
MarketMicrostructureIstheNewFactorinPortfolio
Optimization 176
Yes,YouCanPredictT +1Volatility 178
MarketMicrostructureasaFactor?YouBet. 179
CaseStudy:ImprovingExecutioninCurrencies 183
ForLonger-TermInvestors,IncorporateMicrostructure
intotheRebalancingDecision 184
Conclusions 185
EndofChapterQuestions 185
CHAPTER10
WhyVentureCapitalistsAreBettingonFintechtoManageRisks 187
OpportunitiesforDisruptionArePresent,andTheyMay
NotBeWhatTheySeem 189
(cid:2) DataandAnalyticsinFintech 191 (cid:2)
FintechasanAssetClass 192
WhereDoYouFindFintech? 194
FintechSuccessFactors 194
TheInvestmentCaseforFintech 196
HowDoFintechFirmsMakeMoney? 198
FintechandRegulation 198
Conclusions 200
EndofChapterQuestions 200
Authors’Biographies 201
Index 203
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Acknowledgments
W
e would like to thank our intrepid editor Bill Falloon, and the great
productionteam:JudyHowarth,CherylFerguson,SharmilaSrinivasan,
andMichaelHentonforgreatcoverdesign.
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1
CHAPTER
Silicon Valley Is Coming!
K
nock-knock.
—Whoisthere?
—Bot.
—Botwho?
—Botandsold,it’sastat-arbworld.
Doyouwonderwhythemarketshavechangedsomuch?Where’sitall
heading? How will it affect you? You are not alone. Today’s markets are
verydifferentfromwhattheyusedtobe.Technologicaladvancesmorphed
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computers and infrastructure. Changes in regulation allowed dozens of
exchangestocoexistsidebyside.Theglobalnatureofbusinesshasushered
inround-the-clockdealmaking.Allofthishascreatedstratosphericvolumes
of data. The risks that come along with automated trading in real-time are
numerous.Now,theinferencesfromthesedataallowustogotopreviously
untappeddepthsofmarketsanddiscoverproblemsandsolutionsthatcould
notevenbeimagined20yearsago.
DoyourememberBloombergterminals?Ifso,youarereadingthisbook
not so long after it was written. JP Morgan’s January 2016 announcement
“to pull the plug” on thousands and thousands of Bloomberg terminals
is a leading example of the sweeping disruption facing investment man-
agers. Billion-dollar hedge fund Citadel followed suit on August 16, 2016,
by announcing that it was taking on Symphony messaging as Bloomberg’s
replacement.Symphony,who?Manystillstruggletowraptheirheadaround
thesituation,withsocialmediaplatformslikeLinkedInbuzzingwithdiscus-
sionsaboutpullingtheplugontraditionalsourcesofmarketdata.Yet,here
is fact: The competition is not sleeping, but working hard. And now, the
competitionissostrongthatBloomberg,ThomsonReuters,andothersmay
end up in significant financial peril if they ignore fintech. Is your company
alsooblivioustochangesininnovation?
The unfortunate truth is that many established firms are completely
unpreparedforthefasttrainofinnovationcurrentlypassingthemby.Old,
manual procedures may have been fine in the past, but with innovation
Real-Time Risk: What Investors Should Know About FinTech, High-Frequency Trading, and 1
Flash Crashes, Irene Aldridge and Steve Krawciw
© 2017 by Irene Aldridge and Steve Krawciw. All rights reserved. Published by John Wiley
& Sons, Inc.
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2 REAL-TIMERISK
sweepingthrough,riskmanagementexecutiveshavetobereadytoseeestab-
lished operating models and platforms go out the door as newer, untried
approachestaketheirplace.
Consider the investment advisory industry. Reliance on charming bro-
kerstoseduceever-dwindlingpoolsofclientsintopayingfortheircommis-
sionsandoverheadexpensesremainsthebusinessmodelforsomefirms.At
the same time, a number of well-established startups deliver cutting-edge
portfolio-managementadvicetoinvestorsrightovertheInternet,withsome
chargingaslittleas$9.95permonth.
TRADING FLOOR SUPERVISOR
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GlobalbankslikeBarclay’sandCreditSuissehaveexitedtheUSwealth
managementarenawhileatthesametimehundredsofmillionsofdollarsin
venturefundinghavebeenchanneledtofintechstartupsworkingtostream-
linefinancialadviceandbeyond.
Thebethasbeenwageredthatnewinnovativeandcost-efficientbusiness
models are here to stay. Innovation can take the form of a completely new
approach to conducting business or through advances in the information
used for the existing way of conducting business. As an illustration, while
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