Market Based Control

The London Stock Exchange is rapidly losing market share in equity trading to the nascent dark pools:  on some recent days as much as 20% of trading in LSE’s own equities was not on LSE, but on Chi-X, according to yesterday’s FT. 

“Turquoise yesterday became the second platform to start offering trading after Chi-X launched 14 months ago. Both are tiny compared with the LSE in budget and staff numbers. However, they have heavyweight backers in some big-name investment banks and already Chi-X has made its competitive presence felt. At one point this week, Chi-X captured more than 20 per cent of all trading in FTSE 100 stocks.

Both Chi-X and Turquoise emerged in the wake of rules enacted last year by Brussels that have broken the monopolies of Europe’s established exchanges.

The rules, known as Mifid, require brokers to find “best execution” when a stock is being traded. The move was an invitation to set up new trading venues, spur competition and lower trading fees.

Investment banks poun-ced. Turquoise and Chi-X are not only cheaper than the LSE, but have ultra-fast trading systems that are suited to the high-volume trading strategies of many hedge funds and other institutional investors.

. . .

But the LSE has been on the offensive.  This month, it changed its fee structure, cut prices and tilted its fee incentives towards the new breed of electronic traders that are flocking to the new platforms.

These traders are often little more than complex computer programs run by investment banks, involving little human intervention. Such “algorithmic” trading thrives off tiny shifts in data or economic news, sending orders electronically to be matched in a matter of milliseconds.

Martin Graham, director of markets at the LSE, said the exchange recognises that this type of trading is a “huge structural shift”. He dismissed the notion that the LSE has been slow in adapting.

“We have been living in a competitive environment for a long time at the LSE. Competition was inevitable and planned for,” he said.

The LSE has also unveiled plans for a “dark pool” - a kind of trading venue popular among large institutions. It offers anonymous trading of large blocks of shares, away from the exchange’s publicly visible order book.

In a clever marketing twist, the LSE named the venture Baikal, after the world’s deepest freshwater lake.

Finally, the LSE has been upgrading its TradElect electronic trading system, equipping it for faster trading times and much greater capacity.”

Technorati Tags: dark pools, Mifid, Turquoise, Chi-X, LSE, electronic traders

For this year’s Market Design Tournament, we commissioned a new game web-interface, showing the progress of the game. Several teams have asked us for a copy of this interface for their own internal games, so we have just uploaded it to the CAT sourceforge page.    Thank you to Ronan Bouichet and Benjamin Broix for their work in designing and implementing this web-viewer.

The 2008 TAC Market Design (or CAT) Tournament is now complete, and the winners are:

    First Place:        PersianCAT from Shiraz University, Iran
    Second Place:   MANX, from University of Michigan, USA
    Third Place:      jackaroo, from University of Western Sydney, Australia
    Prize for most successful new entrant: 

       DOG, from King’s College London, UK.

Congratulations to these four winners and to all the 2008 participants for a most successful tournament.

A full list of scores is available here.  Details of the 2008 CAT Tournament will be posted here later in 2008 or early in 2009.

Australia’s only Fields Medallist, Terry Tao, has a post about the Black-Scholes equation, here.

POSTSCRIPT:  Portfolio magazine carried an article critical of Black-Scholes earlier this year:

“Good theory. The glitch was discovered only after the fact: When a market is crashing and no one is willing to buy, it’s impossible to sell short. If too many investors are trying to unload stocks as a market falls, they create the very disaster they are seeking to avoid. Their desire to sell drives the market lower, triggering an even greater desire to sell and, ultimately, sending the market into a bottomless free fall. That’s what happened on October 19, 1987, when the sweet logic of Black-Scholes was shown to be irrelevant in the real world of crashes and panics. Even the biggest portfolio insurance firm, Leland O’Brien Rubinstein Associates (co-founded and run by the same finance professors who invented portfolio insurance), tried to sell as the market crashed and couldn’t.

Oddly, this failure of financial theory didn’t lead Wall Street to question Black-Scholes in general. “If you try to attack it,” says one longtime trader of abstruse financial options, “you’re making a case for your own unintelligence.” The math was too advanced, the theorists too smart; the debate, for anyone without a degree in mathematics, was bound to end badly. But after the crash of 1987, individual traders at big Wall Street firms who sold financial-disaster insurance must have smelled a rat. Across markets—in stocks, currencies, and bonds—the price of insuring yourself against financial disaster rose. This rise in prices and the break with Black-Scholes reflected two new beliefs: one, that huge price jumps were more probable and likely to be more extreme than the Black-Scholes model assumed; and two, that you can’t manufacture an option on the stock market by selling and buying the market itself, because that market will never allow it. When you most need to sell—or to buy—is exactly when everyone else is selling or buying, in effect canceling out any advantage you once might have had.

“No one believes the original assumptions anymore,” says John Seo, who co-manages Fermat Capital, a $2 billion-plus hedge fund that invests in catastrophe bonds—essentially bonds with put options that are triggered by such natural catastrophes as hurricanes and earthquakes. “It’s hard to believe that anyone—yes, including me—ever believed it. It’s like trying to replicate a fire-insurance policy by dynamically increasing or decreasing your coverage as fire conditions wax and wane. One day, bam, your house is on fire, and you call for more coverage?” “

Technorati Tags: Black-Scholes equation

Students of computer history will know that the company which pioneered business applications of the new computer technology in the early 1950s was not a hardware manufacturer, but a lead user, Lyons Tea Shops, a nationwide chain of tea shops in Britain.   Lyons specified, designed, built and deployed their own computers, under the name of Leo (Lyons Electronic Office).  Leo were also the first to conceive and deploy many of the business applications which we now take for granted, such as automated payroll systems and logistics management systems.    One of the leaders in that effort, David Caminer, has recently died at the age of 92.  

LEO was later part of ICL, itself later purchased by Fujitsu.  

Technorati Tags: Lyons Tea Shops, Leo

The 2008 TAC Market Design (or CAT) Tournament will take place at AAAI 2008 in Chicago, IL USA next Monday - Wednesday, 14 - 16 July 2008.   Eleven teams from Australia, Croatia, Egypt, Greece, Iran, the UK and the USA qualified for the final games.  

The aim of this tournament is to encourage research in automated mechanism design, and research papers on the CAT game have already been published in prestigious refereed academic conferences such as AAMAS and ECAI, and the Trading Agent Design and Analysis (TADA) Workshop.   The game is supported by the MBC Project (sponsor of this blog), itself funded by the UK EPSRC as part of a programme applying methods and metaphors from biology, economics and other disciplines to the design and management of complex computer sytems.  The MBC project is using ideas from economics for the specification, design, creation and control of distributed computer systems.  

You will be able to watch the results of three final 2008 CAT games as they proceed, here.

Technorati Tags: mechanism design, complex computer sytems, distributed computer systems

Registration is now open for the First International Workshop on Market-Based Control (MBC2008), to be held in Liverpool, UK, on 1-2 September 2008.  See here for details.

From a call for research proposals just issued by the European Space Agency:

Technorati Tags: European Space Agency