Chennai, Jan 10: In a first of its kind initiative, researchers at the Indian
Institute of Technology-Madras (IIT-M) are studying the impact of Algorithmic
Traders (ATs) on the stock market.
This research is the first-of-its-kind to investigate the impact of Proprietary
Algorithmic Traders’ (PATs’) and Buy-side Algorithmic Traders’ (BATs)’ trading
on market quality and vice versa.
This has significant welfare implications for the securities market as in Algorithmic
Trading, computer programs trade faster than human traders., a release from IIT-M
said today.
The research focused on processes that happen when computer programs predict
market order flow and take over the trading process.
The research on Algorithmic Traders has just started to emerge. Some of the literature
that favours ATs suggests that they offer better prices through lower-order placement
costs and update quotes faster. However, other studies suggest that Algorithmic Traders
create a ‘barrier to entry’ situation for human traders, which deteriorates the market
quality significantly.
This research was led by Prof. P. Krishna Prasanna, Department of Management Studies,
IIT-M and Ms. Devika Arumugam, Fulbright Fellow and a PhD Scholar, Department of
Management Studies, IIT-M.
It examined the impact of ATs on the National Stock Exchange (NSE). The findings were
published in the reputed peer-reviewed journal Applied Economics, Taylor and Francis.
Prof Krishna Prasanna said “existing studies consider ATs as a homogenous group, which
is far from reality. ATs use different algorithms based on their source of funds. So, they are
classified into two categories – PATs and BATs.”
The release said the crucial difference between the two is, PATs trade with their own funds,
and their algorithms are arbitrage seeking, while BATs trade with their clients’ funds and their algorithms are predominantly cost reduction seeking”, he said.
The key learnings and outcomes from this Research included PATs and BATs trade differently
and have a differential impact on the market quality, PATs’ cancellation increases the quoted
spread, while BATs’ order placement reduces the same and BATs’ crowd out PATs’ orders,
but not vice versa.
Ms. Devika Arumugam said these new findings have substantial financial and regulatory
implications. Traders and regulators stand to gain from the market quality enhancing
capabilities of BATs.”
Also, as PATs and BATs trade differently, they have a differential impact on the market quality.
PATs’ cancellation significantly increases the quoted spread, while BATs’ order placement
reduces the same.
The researchers also examined whether PATs and BATs exhibit a “hide-and-seek” behaviour
and find that BATs’ crowd out PATs’ orders but not vice versa.
However, selective regulation of PATs’ strategies is necessary. As BATs crowd out PATs, it
suggests that the rivalry among ATs can counteract any market imbalances created by price
distorting and aggressive algorithmic strategies, thereby enhancing the price efficiency.
These results are primarily based on ATs’ order placement and cancellation activity in the
market.
