Indexes and ETFs
Index arbitrage is driven by the relative mispricings of indexes and their underlying components. Under the Law of One Price, index price should be equal to the price of a portfolio of individual securities composing the index, weighted according to their weights within the index. Occasionally, relative prices of the index and the underlying securities deviate from the Law of One Price and present the following arbitrage opportunities. If the price of the index-mimicking portfolio net of...
Working with Tick Data
Trading opportunities are largely a function of the data that identifies them. As discussed in Chapter 7, the higher the data frequency, the more arbitrage opportunities appear. When researching profitable opportunities, therefore, it is important to use data that is as granular as possible. Recent microstructure research and advances in econometric modeling have facilitated a common understanding of the unique characteristics of tick data. In contrast to traditional low-frequency regularly...
Introduction
High-frequency trading has been taking Wall Street by storm, and for a good reason its immense profitability. According to Alpha magazine, the highest earning investment manager of 2008 was Jim Simons of Renaissance Technologies Corp., a long-standing proponent of high-frequency strategies. Dr. Simons reportedly earned 2.5 billion in 2008 alone. While no institution was thoroughly tracking performance of high-frequency funds when this book was written, colloquial evidence suggests that the...
Evolution of HighFrequency Trading
Advances in computer technology have supercharged the transmission and execution of orders and have compressed the holding periods required for investments. Once applied to quantitative simulations of market behavior conditioned on large sets of historical data, a new investment discipline, called high-frequency trading, was born. This chapter examines the historical evolution of trading to explain how technological breakthroughs impacted financial markets and facilitated the emergence of...
Cointegration
Cointegration is a popular technique used for optimal portfolio construction, hedging, and risk management. Cointegration measures the contemporaneous or lagged effect of one variable on another variable. For example, if both time series x and y represent price time series of two financial securities, cointegration identifies a lead-lag relationship between the two time series. The simplest test for lead-lag relationships can be specified using the following equation, first suggested by Engle...
System Implementation
The models are often built in computer languages such as MatLab that provide a wide range of modeling tools but may not be suited perfectly for high-speed applications. Thus, once the econometric relationships are ascertained, the relationships are programmed for execution in a fast computer language such as C . Subsequently, the systems are tested in paper-trading with make-believe capital to ensure that the systems work as intended and any problems known as bugs are identified and fixed. Once...