► IMI finance professor Andreas Park will discuss his research on financial market trading in the new year as part of the IMI in the Headlines Speaker Series.
Institute for Management & Innovation (IMI) professor, Andreas Park, delves into high-frequency trading, blockchain technology and more
University of Toronto Mississauga professor Andreas Park is an associate professor of finance where he teaches courses on market microstructure, trading, investments, asset pricing and corporate finance.
His most recent projects have involved research on Canadian equity markets, such as the market impact of dark orders, high frequency trading, the market design of trading with blockchain technology and the impact of trading mechanisms – the results of which have been presented at major international academic conferences. Professor Park recently sat down with IMI to discuss the organization of market trading and the future of the financial industry.
Can you describe the current research you're working on?
High-frequency trading describes the behaviour and the interaction of markets with a particular, relatively new type of trader. These are traders that usually use autonomous computer algorithms; they can trade at extremely high speed. What we’re trying to understand is how they impact the market: whether they lead to efficiency gains, whether they create frictions or exploit them in a way that harms other people, or whether they help the market overcome frictions.
Frictions are features of the market which intrinsically hamper the functioning of the market. Some of them are inevitable. For example, in Canada we have over ten different markets where people can trade.These markets are sometimes located at similar locations but sometimes they are at different data centres. For instance, we have data centres where trading occurs in Markham and in Toronto.The physical distance between the two means these markets cannot be physically seamless.
Do high-frequency traders exploit this geographical friction?
I don’t want to say that they exploit it but they certainly use it. There is some evidence that they react extremely quickly to behaviour in one market when they move to another market. To say that this imposes cost analysis is a little more difficult to assess. Clearly there is a possibility of it. It’s very difficult to put a price tag to that though, but it occurs.
What else are you working on?
Another project that I'm working on is dark trading. That is when you send an order to these markets and you don’t know ahead of time whether you have the ability to trade. What the Canadian regulators did in 2012, is require that if you want to offer a price on those markets then you have to offer a price that is better than the other markets which display the quotes by a certain amount. From that point on you would always trade at prices that were half-way between the best price to sell at (the bid) and the best price to buy at (the ask). What that did was make it unprofitable for market makers to deal in this market. Since almost all trading on that market involved some form of market maker, trading in this market ceased to exist.
That market was set up with a particular purpose in mind: it allowed traders to trade only against orders from retail investors -- people like you and I. The reason why the likes of us are attractive counterparties is that in the aggregate we are just as likely to buy and sell on any given day. With these dark trading rules, it was no longer possible to make money off of this using this venue. So, this market died and all of a sudden these desirable orders went back to the normal market and were concentrated in one particular market. That market saw a very significant improvement in liquidity -- which means that it got easier or cheaper to trade on that market. Loosely, liquidity is the ability to trade a quantity quickly at a good price.The important part is that this liquidity was available to all, which indicates that the cream-skimming of retail orders is a negative and shows the value of trading off people like you and I. It showed that by extracting it from the market there is a lack of liquidity elsewhere market-wide.
Can you talk about blockchain technology?
Broadly put, blockchain is a distributed ledger of all past transactions of financial items of value. The distributed part is important because it means that the information is kept at many locations. What blockchain technology allows is the frictionless and secure transfer of value between parties. At the moment when you want to transfer value you need to involve a third party like a bank, credit card company, PayPal or broker. With this technology, you can actually have end investor to end investor direct transfer without involving a third party because the technology takes the role of the trust that you otherwise need. You can see why this is a threat to financial institutions. In principle, you can envision a world where you don’t need bank accounts.
Since the financial crisis, a lot of firms have emerged to provide financial services that are different than those by the traditional industry. For the last two years the financial industry has been in an uproar because some new technologies have been developed which promise to have extremely large cost-savings for banks, in particular, in infrastructure and in areas of settlement for trades which is extremely cumbersome and very expensive and basically works the same way as it did one hundred years ago. But at the same time, the same technology also gives rise to the possibility that many functions that are done by banks and brokers and financial institutions can become redundant as in they can entirely disappear. That’s a huge threat and a huge opportunity for the financial industry.
Do you foresee this happening soon?
It’s not clear when but it will happen and it can happen very quickly. One of my research projects is to think about a case: if we have distributed ledgers for transactions how would that effect the way we can interact with one another? The possibilities are huge and it will change the way our markets are organized compared to what they are now. For instance, if you want to trade a corporate open bond today -- it’s extremely cumbersome and expensive. You have to go to a dealer, you have to potentially pay a large premium in order to trade with that dealer. A transparent distributed ledger would make it much easier for investors to directly identify potential counterparties and to trade faster and at a lower cost. A few years from now, the world of trading will likely look very different from today's. And trading is just the low-hanging fruit -- frictionless transfers of value will affect and change almost all sectors of the economy.
*Story and photo by Sarah Jane Silva for the Institute for Management & Innovation.