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Review_Slides - WonseokOh Reviews March11th,2010...

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IT in Financial Markets Wonseok Oh Reviews March 11th, 2010
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Efficient Market Theory First use of the term, “efficient markets” appears  in a 1965 paper by Eugene Fama Three forms of market efficiency: Weak Form Efficiency Current market price captures all information contained in  past stock price & volume data Semi-Strong Form Efficiency Current market price captures all  publicly  available  information Strong Form Efficiency Current market price captures all information, both  public and  private
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The Impact of IT on Market  Efficiency +: speedy information, transparency, reduced  spreads, increased competition, fast turnover,  low search costs, decimalization, globalization,  crossing, algorithmic trading   -: market fragmentation, market frictions (loss of  price improvements)
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Big Bang Reforms and SEAQ Cut Trading  Costs on London Stock Exchange  Transparent, screen-based dealer market and heightened competition Savings to investors about $400 million per month LSE volume as % of NYSE’s went from 7% in 1985 to 42% in 1994 ROE of LSE member firms 1987-90, -2% 1985 1994 Commission Bid-Ask Spread Volume 100 bps 80 bps 17 bps $280 mil per day $4.1 bil per day 33 bps http://www.youtube.com/watch?v=BwSM55bsCrM
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Automating Markets is Difficult ... and Contentious “Technology and communications bring efficiency; money is made in inefficiency. The dealer will always go for the dark. It’s the investor that will pull it back to the light” John Phelan (1989), then CEO and Chairman, New York Stock Exchange
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6 Algorithmic Trading “placing a buy or sell order of a defined quantity into a quantitative model that automatically  generates the timing of orders and the size of orders based on goals specified by the  parameters and constraints of the algorithm.” A trader-like system that  handles more trades reacts to market movements faster  possesses richer historical data has better calculation capacity than humans Estimates are that 20 to 40 percent of trades in the major global equity exchanges originate  from software-based trading algorithms. Despite their growing presence, many questions about algorithms remain What is the economic logic for trading with algorithms? What is an algorithmic trading platform? What are the types of trading algorithms employed and what are their objectives?
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7 The Economic Rationale for  Algorithms Early statistical tests of random walk by financial economists  using day-to-day price movements were largely supportive of the  weak form of the Efficient Markets Hypothesis (EMH).  More recent analyses of intraday tick-by-tick data however show  contradictory results (Lo and MacKinlay, 1999). 
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This note was uploaded on 03/23/2010 for the course INSY INSY434 taught by Professor Oh during the Winter '10 term at McGill.

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Review_Slides - WonseokOh Reviews March11th,2010...

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