Friday, December 28, 2012

High-speed trading lobby and its conflicted paid for research

The Wall Street Journal carried an article describing how the high-speed trading lobby is trying to fend off regulation using research it pays for.

This practice is routine for lobbyists as they use it to shape policy makers perceptions of the issues.  The banking industry has engaged in similar activities.
The chief executive of Knight Capital Group Inc. KCG told Congress in June that rapid-fire trading, the backbone of its business, is a boon to the overall stock market. He cited a study that cautioned regulators against unintended consequences of curbing the practice known as high-frequency trading. 
It was a 2010 study Knight itself had commissioned. Its lead author that year joined the board of a stock-exchange company that caters to high-speed traders and is partly owned by Knight. 
Less than two months after the Knight executive's testimony, Knight nearly imploded when computerized trades went haywire, costing it $461 million in losses. Last week, the hobbled firm agreed to a takeover. 
High-frequency trading firms are fighting to fend off regulation as scrutiny of their practice of unleashing blizzards of orders coincides with repeated technical glitches in the markets. 
As the firms work to convince policy makers their practices are benign or even beneficial, one of their primary tools has been research seeded by the industry itself, promoted by lobbying that has increased in recent years. 
Yet research conclusions presented as firm endorsements of high-frequency trading don't always square with reservations harbored by some researchers themselves, who question how far existing studies can go to pin down the effect rapid trading has on the overall market.
The studies have value but also shortcomings, says the researcher hired and quoted by Knight, James Angel, a finance professor at Georgetown University. "Not even the exchanges have all the data," Mr. Angel said in an email. "We see a big jumble and it is impossible to pick out the good from the bad."
Mr. Angel said Knight's payment didn't influence his conclusions. Knight's sponsorship was noted by the firm's CEO, Thomas Joyce, in his appearance before Congress in June, though not in written testimony ahead of the hearing that also quoted the Angel paper. A spokeswoman for Knight said the Jersey City, N.J., firm "supports research that helps foster a better understanding of market structure."
Other research that rapid-fire-trading firms have cited includes additional papers paid for by such firms and a study whose author was hoping to sell software to computerized traders.

Please re-read the highlighted text as it raises a number of interesting points.

First, it raises the issue of the need for transparency so that market participants, including academic researchers and regulators, have all the data and can pick out the good from the bad.

Second, it raises the issue of using the school's reputation to hide the fact that the research was paid for by the industry.  The researcher's credibility is directly linked to the reputation of the school the researcher works for.  However, the school is clearly not endorsing the outcome of the research.

Third, it raises the issue of using the school's reputation to hide the researcher's motivation.

In high-frequency trading, computers place thousands of buy and sell orders and instantly cancel many of them, having placed them just to test demand. Such trading has come to dominate U.S. stock markets, making up more than half of daily volume, and increasingly influences how currencies, commodities and other assets trade. 
It is at the center of a debate about the future of financial markets. 
Defenders say high-frequency trading keeps markets lubricated with a constant supply of buy and sell orders that enables all participants to trade more efficiently and get better pricing..... 
Critics, for their part, worry that the traders' order torrent makes markets more opaque, less stable and ultimately less fair.
The absence of data cited by the industry's own researcher strongly suggests the critics are right that high speed trading makes the markets more opaque, less stable and ultimately less fair.

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