How Algorithmic Traders Put An Impact On Stock Market: IIT-Madras Study

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The researchers found that PAT and BAT have a differential impact on the market quality

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New Delhi:

The researchers of Indian Institute of Technolog (IIT Madras) 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. The research was led by Prof. P. Krishna Prasanna, Department of Management Studies and Ms. Devika Arumugam, Fulbright Fellow and a PhD Scholar, Department of Management Studies, IIT Madras.

The researchers found that Proprietary Algorithmic Traders’ (PATs’) and Buy-side Algorithmic Traders’ (BATs) trade differently and have a differential impact on the market quality. “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,” s. Devika Arumugam, Ph.D. scholar and Fulbright Fellow, Department of Management Studies, IIT Madras, said.

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, the professor said.

According to IIT-Madras, the research has significant welfare implications for the securities market as in Algorithmic Trading, computer programs trade faster than human traders. “Some of the literature that favours Algorithmic Traders 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,” the release mentioned.