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18th Annual Workshop on Financial Engineering: High Frequency Trading and Market Microstructure

Friday October 21, 2011, 8:45 AM- 6:30 PM Uris Hall, Room 301 Columbia University, New York

Hosted by the Center for Financial Engineering The advent of electronic trading has transformed financial markets markets, which are now faced with a flow of supply and demand at various frequencies across a fragmented range of venues. This new high-frequency environment has created a new set of quantitative challenges for investors, market makers, and regulators. In this conference, we will seek to explore and understand some of these challenges. Topics : Market microstructure, Market making, High-frequency trading, Limit order markets, algorithmic trading, optimal trade execution, dark pools, econometrics of high-frequency data.
Sponsored by

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Program :

8:00 - 8:45 8:45 - 9:00 9:00 - 9:45

Registration and coffee Introduction


Matt Cushman (Citadel) High Frequency Market Making

9:45 - 10:30 Jim Gatheral (Baruch College) Optimal order execution 9:00 - 11:00 Coffee break 11:00-11:45 Robert Almgren (Quantitative Brokers) The Microstructure of Interest rate futures markets 11:45 - 12:30 Ciamac Moallemi (Columbia University) Optimal Order Flow Routing, Exchange Competition and the Effect of Make/Take Fees 12:30 - 14:00 LUNCH

14:00 - 14:45 Rama Cont (Columbia University) Price dynamics in limit order markets: linking volatility and order flow

14:45 - 15:30 Sasha Stoikov (Cornell University) Forecasting Prices from Level-1 Quotes in the Presence of Hidden Liquidity 15:30 - 16:00 Coffee break 16:00 - 16:45 Albert Kyle (University of Maryland) Market Microstructure Invariants 16:45 - 17:45 Panel Discussion: High Frequency trading: market reality, perspectives and regulation
Brad Banks (Athena Capital Research) Larry Glosten (Columbia University) Costis Maglaras (Columbia University) Michael Sotiropoulos (Bank of America Merrill Lynch) 17:45 18:30 Cocktails (Hepburn Lounge)

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Email: cfe@columbia.edu

www.cfe.columbia.edu

Email: cfe@columbia.edu

ABSTRACTS
High frequency Market Making
Matt Cushman Citadel Investment Group Abstract The term "high frequency trading" encompasses many different strategies and market activities. One of the more important strategies by volume is market making, which fundamentally is the process of providing liquidity to longer term investors and traders who are willing to pay a premium for an immediate execution. Indeed, automated trading strategies have nearly completely replaced the traditional human market maker in many electronic markets. A successful market maker must contend with many issues such as information asymmetry and adverse selection in order to be successful. In this talk we discuss the current state of some specific markets, and describe in mathematical terms some models that can help one understand the dilemma of when to provide liquidity. Biography Matthew Cushman has a decade of experience in quantitative trading. He is currently Senior Managing Director at Citadel Investment Group, where he joined in 2011 to cohead a new automated, quantitative trading team. Prior to joining Citadel, Cushman was the head of the quantitative research team at Knight Capital Group, where he had worked since 2002. At Knight he pioneered a systematic, algorithmic approach to market making to provide automated liquidity to the equity markets. He has also taught a course in market microstructure and quantitative trading at Rutgers University. Cushman graduated from Carnegie Mellon University in 1995 with an MS in Mathematics as well as a BS in Mathematics and Logic and Computation, with a minor in Computer Science. He earned his PhD in Mathematics in 2000 from the University of Chicago.

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Optimal Order Execution Jim Gatheral Baruch College Abstract We review various models of market impact. We use variational calculus to derive optimal execution strategies, noting that in many conventional models, static strategies are dynamically optimal. We then present a model in which the optimal strategy does depend on the stock price and derive an explicit closed-form solution for this strategy by solving the HJB equation. We discuss price manipulation, indicating modeling choices for which this is unlikely to be a problem. We present a recent argument by Toth et al. that justifies the well-known square-root formula for market impact. Assuming price dynamics that are consistent with the square-root formula, we suggest likely properties of optimal execution strategies. Biography Jim Gatheral is professor at Baruch College (CUNY) which he joined in 2010, after 17 years in the Equity Quantitative Analytics group at Merrill Lynch. His research focuses on volatility modeling, optimal execution and modeling of price impact. He is the author of The Volatility Surface: A Practitioners Guide (Wiley).

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The Microstructure of Interest Rate Futures Markets Robert Almgren Quantitative Brokers Abstract Interest rate futures markets present several novel microstructural features not found in equities and other futures markets. For algorithmic trade execution, these features must be fully understood and properly exploited. Three features are the most important. First is pro rata order matching, which has strong effects on the order book dynamics and response to large trades. Second is implied quoting via calendar spread and butterfly contracts, which presents opportunities to find hidden liquidity and better order fills. Third is the highly coupled nature of contracts at different points on the yield curve. We shall provide an overview of all these aspects, and the quantitative tools used to model them. Biography Robert Almgren, co-founder of Quantitative Brokers, providing agency algorithmic execution and cost measurement in interest rate markets, and Fellow in the Mathematics in Finance Program at New York University. Until 2008, Dr Almgren was a Managing Director and Head of Quantitative Strategies in the Electronic Trading Services group of Banc of America Securities. From 2000-2005, he was a tenured Associate Professor of Mathematics and Computer Science at the University of Toronto, and Director of its Master of Mathematical Finance program. Before that, he was an Assistant Professor of Mathematics at the University of Chicago and Associate Director of the Program on Financial Mathematics. Dr. Almgren holds a B.S. in Physics and Mathematics from the Massachusetts Institute of Technology, an M.S. in Applied Mathematics from Harvard University and a Ph.D. in Applied and Computational Mathematics from Princeton University. He has an extensive research record in applied mathematics, including papers on optimal trading, transaction cost measurement, and portfolio construction.

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Optimal Order Flow Routing and the Effect of Make/Take Fees Ciamac Moallemi Graduate School of Business Columbia University Abstract In modern equity markets, traders have the choice of many exchanges, each operating as an electronic limit order book that can be modeled as a pair of multiclass queues under a price/time priority rule. The dynamics are coupled via price protection mechanisms. We present a model to study the order routing problem, characterize market equilibria, and derive insights of the queue, delay and adverse selection measures of different exchanges. We present empirical data that supports our findings. This is joint work with Costis Maglaras and Hua Zheng. Biography Ciamac C. Moallemi is an Associate Professor in the Decision, Risk, and Operations Division of the Graduate School of Business at Columbia University, where he has been since 2007. He received S.B. degrees in Electrical Engineering & Computer Science and in Mathematics from the Massachusetts Institute of Technology (1996). He studied at the University of Cambridge, where he earned a Certificate of Advanced Study in Mathematics, with distinction (1997). He received a Ph.D. in Electrical Engineering from Stanford University (2007). Prior to his doctoral studies, he developed quantitative methods in a number of entrepreneurial ventures: as a partner in a $200 million fixedincome arbitrage hedge fund, as the director of scientific computing at an early-stage drug discovery start-up, and as the founder of a computer security software start-up. He is an associate editor of Operations Research. He is a member of the IEEE and INFORMS. He is the recipient of a British Marshall Scholarship (1996) and a Benchmark Stanford Graduate Fellowship (2003). His research interests are in the area of the optimization and control of large scale stochastic systems, with an emphasis on applications in financial engineering.

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Price Dynamics in Limit Order Markets: Linking Volatility with Order Flow Rama Cont, Columbia University Joint work with: Adrien DE LARRARD (Universite de Paris VI) The high-frequency dynamics of prices, supply and demand in electronic markets may be described in terms of a limit order book, whose dynamics has a natural description as a point process or queueing system [1,2,3]. We present a model for the arrival and execution of limit and market orders which allows for correlated durations between orders, random heterogeneous and correlated order sizes and temporal dependence in the order flow. Our models includes Poisson, self-exciting and ACD models as special cases. We show that in liquid markets, where orders arrive with high frequency, the dynamics of buy and sell queues may be approximated by a Markovian jump-diffusion process whose parameters are easily estimated from the observed order flow [4]. This approximation provides an analytically tractable description of the dynamics of the order book and the market price and yields a quantitative link between price volatility and high frequency order flow, providing quantitative insight into the link between liquidity and price volatility in limit order markets [2,4]. Our model enables to compute endogenously statistical properties of the price process in terms of statistical properties of the order flow, without recourse to ad-hoc assumptions on price impact. In particular, we obtain an expression for the (low-frequency) volatility of the price in terms of the first and second moments of the order flow at high frequency. These relations are found to be in good agreement with empirical data for US stocks. [1] Rama Cont, Sasha Stoikov and Rishi Talreja (2010) A stochastic model for order book dynamics, Operations Research, Volume 58, No. 3, 549-563. [2] Rama Cont and Adrien de Larrard (2010) Price dynamics in a Markovian limit order market, http://ssrn.com/abstract=1735338 [3] Rama Cont (2011) Statistical Modeling of High Frequency Financial Data: Facts, Models and Challenges, IEEE Signal Processing, Volume 28, No 5, p 16-25. [4] Rama Cont and Adrien de Larrard (2010) Price dynamics in limit order markets: linking volatility and order flow, Working Paper. Biography Rama Cont is Associate professor at Columbia Engineering, director of the Center for Financial Engineering and Associate Research Scientist at the French Center for Scientific Research (CNRS). His research focuses on quantitative methods in risk management, credit risk, systemic risk, stochastic modeling and computational methods in finance. He has taught at Ecole Polytechnique, Princeton University, Universite de Paris VI, HEC and held industry consulting positions with NYSE, DTCC, ICE, SocGen, DRW Trading, Total Trading, Bovespa and other financial institutions in the US and Europe on various issues related to quantitative risk management, derivative pricing, automated trading algorithms, design of central clearing facilities for OTC contracts and systemic risk. He is the Editor in Chief of the Encyclopedia of Quantitative Finance (2010) and author of Financial Modeling with Jump processes (2004).

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Forecasting Prices from Level-1 Quotes in the Presence of Hidden Liquidity Sasha Stoikov Cornell University & Cantor Fitzgerald Abstract Bid and ask sizes at the top of the order book provide information on short-term price moves. Drawing from classical descriptions of the order book in terms of queues and order-arrival rates (Smith et al (2003)), we consider a diffusion model for the evolution of the best bid/ask queues. We compute the probability that the next price move is upward, conditional on the best bid/ask sizes, the hidden liquidity of the market and the correlation between changes in the bid/ask sizes. The model can be useful, among other things, to rank trading venues in terms of the "information content" of their quotes and to estimate the hidden liquidity in a market based on high-frequency data. We illustrate the approach with an empirical study of a few liquid stocks using quotes from various exchanges. Biography Sasha Stoikov is a senior research associate at Cornell Financial Engineering Manhattan (CFEM) and a VP in the High Frequency Trading group at Cantor Fitzgerald. He has worked as a consultant at the Galleon Group and Morgan Stanley and was an instructor at the Courant Institute of NYU and at Columbias IEOR department. He holds a Ph.D. from the University of Texas and a BS from MIT.

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Market Microstructure Invariants Albert S. Kyle Robert H. Smith School of Business University of Maryland Abstract The hypothesis of market microstructure invariancebased on the intuition that stocks vary on a time scale according to which bets generate trading activityis tested using a database of 400,000+ portfolio transition trades. Defining trading activity W as the product of dollar volume and returns standard deviation, microstructure invariance predicts that order size, market impact costs, and bid-ask spread costsas fractions of daily volumeare proportional to W2/3, W1/3, and W1/3, respectively. Estimated exponents are -0.63, 0.33, and -0.39, respectively, with order order size conforming to a log-normal distribution. Calibration leads to a simple transaction cost formula based on trade size, volume, and volatility. Biography Professor Albert S. (Pete) Kyle has been the Charles E. Smith Chair Professor of Finance at the University of Marylands Robert H. Smith School of Business since 2006. He earned is B.S. degree in mathematics from Davidson College (summa cum laude, 1974), studied philosophy and economics at Oxford University as a Rhodes Scholar from Texas (1974-1977), and completed his Ph.D. in economics at the University of Chicago in 1981. He has been a professor at Princeton University (1981-1987), the University of California Berkeley (1987-1992), and Duke University (1992-2006). Professor Kyles research focuses on market microstructure, including topics such as high frequency trading, informed speculative trading, market manipulation, price volatility, the informational content of market prices, market liquidity, and contagion. His current research also deals with concepts from industrial organization to value companies. His teaching interests include market microstructure, institutional asset management, venture capital and private equity, corporate finance, option pricing, and asset pricing. He is a Fellow of the Econometric Society (since 2002). He has been a board member of the American Finance Association (2004-2006), a staff member of the Presidential Task Force on Market Mechanisms (Brady Commission, 1987), a consultant to the SEC's Office of Inspector General, a member of NASDAQs economic advisory board (20042007), a member of the FINRA economic advisory committee (2010-2011), and a member of the CFTCs Technology Advisory Committee (2010-2011).

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PANEL DISCUSSION High Frequency trading: market reality, perspectives and regulation
Costis Maglaras Graduate School of Business, Columbia University Costis Maglaras is the David and Lyn Silfen Professor of Business at Columbia University. He is a member of the Decision, Risk, and Operations division at the business school since 1998. His research focuses on the application of stochastic modeling and applied mathematics in quantitative finance, economics and engineering applications. His recent research focus has been on the study of high-frequency market microstructure and the study of herding and social learning on networks and markets. He is the codirector of the Business School's PhD program, and the program director for its Executive Education course on Risk Management. Costis also serves as the Head of Research at Mismi, a quantitative broker dealer, where he has been responsible for the design and development of its portfolio crossing technology, its trade execution algorithms, market microstructure analytics, and quant research efforts. Brad Banks Athena Capital Research Brad Banks founded Athena Capital Research in June 2003. He is responsible for overall management and growth of the company, in addition to overseeing research, development, and risk management of investment strategies. He was previously a Managing Director at Tower Research Capital, a highly successful early pioneer in automated electronic trading. He has 12 years of industry experience covering operations, personnel, and portfolio management, as well as development of quantitative trading strategies. Brad received SB and MEng degrees in computer science from the Massachusetts Institute of Technology in 1999. His graduate thesis research focused on the extraction of patterns from large data sets through statistical and machine learning techniques.

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Larry Glosten Graduate School of Business Columbia University Lawrence R. Glosten is the S. Sloan Colt Professor of Banking and International Finance at the Columbia Business School of Columbia University. He has been at Columbia since 1989, before which he taught at the Kellogg Graduate School of Management at Northwestern University, and has held visiting appointments at the University of Chicago and the University of Minnesota. He has published articles on the industrial organization of securities markets, the relationship between venture capitalists and entrepreneurs, evaluating the performance of portfolio managers and asset pricing. His work on electronic exchanges in the Journal of Finance won a Smith Breeden Prize for best paper. He has served as an editor at the Review of Financial Studies, associate editor at the Journal of Finance and serves on several other editorial boards. He has consulted for the New York Stock Exchange, Valumetrics and the MidAmerica Institute for Public Policy. He received his AB from Occidental College and his Ph.D. in managerial economics from Northwestern University. Michael Sotiropoulos Bank of America Merrill Lynch Michael Sotiropoulos is the global head of algorithmic trading quantitative research at Bank of America Merrill Lynch. His group supports the Global Execution Services and Portfolio Trading businesses, focusing on market microstructure and algorithmic trading research and development. Michael joined Bank of America in 2004, as an equity derivatives quant after spending three years at Bear Stearns in the same role. He was head of equity derivatives quantitative research for year 2008 before moving to algorithmic trading. He has a Ph.D. in Theoretical Physics from SUNY Stony Brook. Prior to joining the finance industry he taught and worked in quantum field theory and particle physics at the University of Southampton, England and at the University of Michigan.

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