Three academics have identified a market structure they contend would enhance liquidity and stability, overcoming detrimental impacts to investors of high-frequency trading.
The men call for scrapping the current market structure of so-called continuous buying and selling of stocks at any time that has led to the technology “arms race” to trade ever faster that harms liquidity and raises costs for institutional investors.
They propose instead trading in discrete time intervals — of, say, every second or every millisecond — they claim would strengthen the position of investors.
“Stocks trade in pennies,” or discrete prices, said Eric Budish, associate professor of economics at the University of Chicago Booth School of Business, in an interview. “If you want to bid more than me, you have to bid at least a penny more than my bet. You can't bid a millionth or a billionth (penny) more than my bid. And that's the sense that prices are discrete. There is a minimum price increment.
“There are good reasons for that. And we're in a sense arguing for a minimum time increment” for trading, he said.
Mr. Budish — along with Peter Cramton, professor of economics, University of Maryland, College Park, and John J. Shim, Chicago Booth School doctoral candidate in finance — co-authored an unpublished paper outlining their market restructuring idea. The paper, “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response,” was the winner of the $100,000 AQR Capital Management LLC Insight Award, announced May 21.
The Budish team earlier this year was beginning to generate interest in their potential solution, even before Michael Lewis' controversial book, “The Flash Boys: A Wall Street Revolt,” was released and drew significant public attention to the issues raised by high-frequency trading.
“There is a lot of interest in the work” proposing discrete trading intervals, Mr. Budish said.
Mary Jo White, chairwoman of the Securities and Exchange Commission, said in a June 5 speech that “today's technology-driven market ... may work against, or at least not optimally for, the interests of investors and companies. ... I am receptive to more flexible, competitive solutions that could be adopted by trading venues. These could include frequent batch auctions or other mechanisms designed to minimize speed advantages.” Ms. White's comments come after comments in May by Mr. Budish before officials at an SEC conference on financial market regulation and at a meeting of the Financial Industry Regulatory Authority.
Mr. Budish recently also discussed his ideas with representatives of pension funds, investment managers, broker-dealers, exchanges, high-frequency trading firms and regulators, he said. He declined to identify the private entities.