164 research outputs found
David vs Goliath (You against the Markets), A Dynamic Programming Approach to Separate the Impact and Timing of Trading Costs
We develop a fundamentally different stochastic dynamic programming model of
trading costs. Built on a strong theoretical foundation, our model provides
insights to market participants by splitting the overall move of the security
price during the duration of an order into the Market Impact (price move caused
by their actions) and Market Timing (price move caused by everyone else)
components. We derive formulations of this model under different laws of motion
of the security prices, starting with a simple benchmark scenario and extending
this to include multiple sources of uncertainty, liquidity constraints due to
volume curve shifts and relating trading costs to the spread. We develop a
numerical framework that can be used to obtain optimal executions under any law
of motion of prices and demonstrate the tremendous practical applicability of
our theoretical methodology including the powerful numerical techniques to
implement them. Our decomposition of trading costs into Market Impact and
Market Timing allows us to deduce the zero sum game nature of trading costs. It
holds numerous lessons for dealing with complex systems, wherein reducing the
complexity by splitting the many sources of uncertainty can lead to better
insights in the decision process
Microstructure under the Microscope: Tools to Survive and Thrive in The Age of (Too Much) Information
Market Microstructure is the investigation of the process and protocols that
govern the exchange of assets with the objective of reducing frictions that can
impede the transfer. In financial markets, where there is an abundance of
recorded information, this translates to the study of the dynamic relationships
between observed variables, such as price, volume and spread, and hidden
constituents, such as transaction costs and volatility, that hold sway over the
efficient functioning of the system.
"My dear, here we must process as much data as we can, just to stay in
business. And if you wish to make a profit you must process at least twice as
much data." - Red Queen to Alice in Hedge-Fund-Land.
In this age of (Too Much) Information, it is imperative to uncover nuggets of
knowledge (signal) from buckets of nonsense (noise). To aid in this effort to
extract meaning from chaos and to gain a better understanding of the
relationships between financial variables, we summarize the application of the
theoretical results from (Kashyap 2016b) to microstructure studies. The central
concept rests on a novel methodology based on the marriage between the
Bhattacharyya distance, a measure of similarity across distributions, and the
Johnson Lindenstrauss Lemma, a technique for dimension reduction, providing us
with a simple yet powerful tool that allows comparisons between data-sets
representing any two distributions. We provide an empirical illustration using
prices, volumes and volatilities across seven countries and three different
continents. The degree to which different markets or sub groups of securities
have different measures of their corresponding distributions tells us the
extent to which they are different. This can aid investors looking for
diversification or looking for more of the same thing.Comment: arXiv admin note: substantial text overlap with arXiv:1603.0906
Fighting Uncertainty with Uncertainty: A Baby Step
We can overcome uncertainty with uncertainty. Using randomness in our choices
and in what we control, and hence in the decision making process, could
potentially offset the uncertainty inherent in the environment and yield better
outcomes. The example we develop in greater detail is the news-vendor inventory
management problem with demand uncertainty. We briefly discuss areas, where
such an approach might be helpful, with the common prescription, "Don't Simply
Optimize, Also Randomize; perhaps best described by the term -
Randoptimization".
1. News-vendor Inventory Management
2. School Admissions
3. Journal Submissions
4. Job Candidate Selection
5. Stock Picking
6. Monetary Policy
This methodology is suitable for the social sciences since the primary source
of uncertainty are the members of the system themselves and presently, no
methods are known to fully determine the outcomes in such an environment, which
perhaps would require being able to read the minds of everyone involved and to
anticipate their actions continuously. Admittedly, we are not qualified to
recommend whether such an approach is conducive for the natural sciences,
unless perhaps, bounds can be established on the levels of uncertainty in a
system and it is shown conclusively that a better understanding of the system
and hence improved decision making will not alter the outcomes
Solving Society's Big Ills, A Small Step
We look at a collection of conjectures with the unifying message that smaller
social systems, tend to be less complex and can be aligned better, towards
fulfilling their intended objectives. We touch upon a framework, referred to as
the four pronged approach that can aid the analysis of social systems. The four
prongs are:
1. The Uncertainty Principle of the Social Sciences
2. The Objectives of a Social System or the Responsibilities of the Players
3. The Need for Smaller Organizations
4. Redirecting Unintended Outcomes
Smaller organizations mitigating the disruptive effects of corruption is
discussed and also the need for organizations, whose objective is to foster the
development of other smaller organizations. We consider a way of life, which is
about respect for knowledge and a desire to seek it. Knowledge can help
eradicate ignorance, but the accumulation of knowledge can lead to
overconfidence. Hence it becomes important to instill an attitude that does not
knowledge too seriously, along with the thirst for knowledge. All of this is
important to create an environment that is conducive for smaller organizations
and can be viewed as a natural extension of studies that fall under the wider
category of understanding factors and policies aimed at increasing the welfare
or well-being to society.Comment: arXiv admin note: substantial text overlap with arXiv:1603.0099
Dynamic Multi-Factor Bid-Offer Adjustment Model: A Feedback Mechanism for Dealers (Market Makers) to Deal (Grapple) with the Uncertainty Principle of the Social Sciences
The author seeks to develop a model to alter the bid-offer spread, currently
quoted by market makers, that varies with the market and trading conditions.
The dynamic nature of financial markets and trading, as with the rest of social
sciences, where changes can be observed and decisions can be made by
participants to influence the system, means that this model has to be adaptive
and include a feedback loop that alters the bid-offer adjustment based on the
modifications observed in the market and trading conditions, without a
significant time delay.
The factors used to adjust the spread are price volatility, which is publicly
observable, and trade count and volume, which are generally known only to the
market maker, in various instruments over different historical durations in
time. The contributions of each factor to the bid-offer adjustment are computed
separately and then consolidated to produce a very adaptive bid-offer
quotation. The author uses the currency markets to build the sample model
because they are extremely liquid and trading in them is not as transparent as
other financial instruments, such as equities. Simulating the number of trades
and the average size of trades from a lognormal distribution, the parameters of
the lognormal distributions are chosen such that the total volume in a certain
interval matches the volume publicly mentioned by currency trading firms. This
methodology can easily be extended to other financial instruments and possibly
to any product with the ability to make electronic price quotations, or can
even be used to periodically perform manual price updates on products that are
traded non-electronically
Auction Theory Adaptations for Real Life Applications
We develop extensions to auction theory results that are useful in real life
scenarios.
1. Since valuations are generally positive we first develop approximations
using the log-normal distribution. This would be useful for many finance
related auction settings since asset prices are usually non-negative.
2. We formulate a positive symmetric discrete distribution, which is likely
to be followed by the total number of auction participants, and incorporate
this into auction theory results.
3. We develop extensions when the valuations of the bidders are
interdependent and incorporate all the results developed into a final combined
realistic setting.
4. Our methods can be a practical tool for bidders and auction sellers to
maximize their profits. The models developed here could be potentially useful
for inventory estimation and for wholesale procurement of financial instruments
and also non-financial commodities.
All the propositions are new results and they refer to existing results which
are stated as Lemmas.Comment: arXiv admin note: substantial text overlap with arXiv:1603.0098
The Economics of Enlightenment: Time Value of Knowledge and the Net Present Value (NPV) of Knowledge Machines, A Proposed Approach Adapted from Finance
We formulate one methodology to put a value or price on knowledge using well
accepted techniques from finance. We provide justifications for these finance
principles based on the limitations of the physical world we live in. We start
with the intuition for our method to value knowledge and then formalize this
idea with a series of axioms and models. To the best of our knowledge this is
the first recorded attempt to put a numerical value on knowledge. The
implications of this valuation exercise, which places a high premium on any
piece of knowledge, are to ensure that participants in any knowledge system are
better trained to notice the knowledge available from any source. Just because
someone does not see a connection does not mean that there is no connection. We
need to try harder and be more open to acknowledging the smallest piece of new
knowledge that might have been brought to light by anyone from anywhere about
anything
Seven Survival Senses: Evolutionary Training makes Discerning Differences more Natural than Spotting Similarities
We discuss preliminary results from two experiments and put forth the notion
that the development of sensory systems might be more geared towards discerning
differences rather than for spotting similarities. We present the possibility
that the necessity to spot differences might have evolved to ensure the
survival of the organism, which suggests numerous other experiments to assess
the response of participants to various stimuli. We consider our present state
of affairs, wherein the need is to thrive and not merely survive, which
requires us to spot similarities around us. We provide some suggestions on how
this attribute can be developed, which includes mathematical education. We
conclude with an alternate measure for intelligence, termed the Involvement
Quotient (also, IQ), which gauges the level of involvement of the sense organs
to whatever is happening around the individual.Comment: World Future
A Tale of Two Consequences: Intended and Unintended Outcomes of the Japan TOPIX Tick Size Changes
We look at the effect of the tick size changes on the TOPIX 100 index names
made by the Tokyo Stock Exchange on Jan-14-2014 and Jul-22-2104. The intended
consequence of the change is price improvement and shorter time to execution.
We look at security level metrics that include the spread, trading volume,
number of trades and the size of trades to establish whether this goal is
accomplished. An unintended effect might be the reduction in execution sizes,
which would then mean that institutions with large orders would have greater
difficulty in sourcing liquidity. We look at a sample of real orders to see if
the execution costs have gone up across the orders since the implementation of
this change.
We study the mechanisms that affect how securities are traded on an exchange,
before delving into the specifics of the TSE tick size events. Some of the
topics we explore are: The Venue Menu and How to Increase Revenue; To Automate
or Not to Automate; Microstructure under the Microscope; The Price of
Connections to High (and Faraway) Places; Speed Thrills but Kills; Pick a Size
for the Perfect Tick; TSE Tick Size Experiments, Then and Now; Sergey Bubka and
the Regulators; Bird`s Eye View; Deep Dive; Possibilities for a Deeper Dive;
Does Tick Size Matter? Tick Size Does Matter!Comment: This version has a mathematical proof to show conditions under which
endogeneity is resolved when doing a regression. The idea is consider the
changes in the coefficients before and after an event. This theoretical proof
is illustrated using the data from our event stud
Michael Milken: The Junk Dealer
We take a closer look at the life and legacy of Micheal Milken. We discuss
why Michael Milken, also know as the Junk Bond King, was not just any other
King or run-of-the-mill Junk Dealer, but "The Junk Dealer". We find parallels
between the three parts to any magic act and what Micheal Milken did, showing
that his accomplishments were nothing short of a miracle. His compensation at
that time captures to a certain extent the magnitude of the changes he brought
about, the eco-system he created for businesses to flourish, the impact he had
on the wider economy and also on the future growth and development of American
Industry. We emphasize two of his contributions to the financial industry that
have grown in importance over the years. One was the impetus given to the
Private Equity industry and the use of LBOs. The second was the realization
that thorough research was the key to success, financial and otherwise. Perhaps
an unintended consequence of the growth in junk bonds and tailored financing
was the growth of Silicon valley and technology powerhouses in the California
bay area. Investors witnessed that there was a possibility for significant
returns and that financial success could be had due to the risk mitigation that
Milken demonstrated by investing in portfolios of so called high risk and low
profile companies. We point out the current trend in many regions of the world,
which is the birth of financial and technology firms and we suggest that
finding innovative ways of financing could be the key to the sustained growth
of these eco-systems
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