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Algorithmic and High-Frequency Trading

Book Description

The design of trading algorithms requires sophisticated mathematical models backed up by reliable data. In this textbook, the authors develop models for algorithmic trading in contexts such as executing large orders, market making, targeting VWAP and other schedules, trading pairs or collection of assets, and executing in dark pools. These models are grounded on how the exchanges work, whether the algorithm is trading with better informed traders (adverse selection), and the type of information available to market participants at both ultra-high and low frequency. Algorithmic and High-Frequency Trading is the first book that combines sophisticated mathematical modelling, empirical facts and financial economics, taking the reader from basic ideas to cutting-edge research and practice. If you need to understand how modern electronic markets operate, what information provides a trading edge, and how other market participants may affect the profitability of the algorithms, then this is the book for you.

Table of Contents

  1. Coverpage
  2. Halftitle page
  3. Title page
  4. Copyright page
  5. Dedication page
  6. Contents
  7. Preface
  8. How to Read this Book
  9. Part I Microstructure and Empirical Facts
    1. Introduction to Part One
    2. 1 Electronic Markets and the Limit Order Book
      1. 1.1 Electronic markets and how they function
      2. 1.2 Classifying Market Participants
      3. 1.3 Trading in Electronic Markets
        1. 1.3.1 Orders and the Exchange
        2. 1.3.2 Alternate Exchange Structures
        3. 1.3.3 Colocation
        4. 1.3.4 Extended Order Types
        5. 1.3.5 Exchange Fees
      4. 1.4 The Limit Order Book
      5. 1.5 Bibliography and Selected Readings
    3. 2 A Primer on the Microstructure of Financial Markets
      1. 2.1 Market Making
        1. 2.1.1 Grossman-Miller Market Making Model
        2. 2.1.2 Trading Costs
        3. 2.1.3 Measuring Liquidity
        4. 2.1.4 Market Making using Limit Orders
      2. 2.2 Trading on an Informational Advantage
      3. 2.3 Market Making with an Informational Disadvantage
        1. 2.3.1 Price Dynamics
        2. 2.3.2 Price Sensitive Liquidity Traders
      4. 2.4 Bibliography and Selected Readings
    4. 3 Empirical and Statistical Evidence: Prices and Returns
      1. 3.1 Introduction
        1. 3.1.1 The Data
        2. 3.1.2 Daily Asset Prices and Returns
        3. 3.1.3 Daily Trading Activity
        4. 3.1.4 Daily Price Predictability
      2. 3.2 Asset Prices and Returns Intraday
      3. 3.3 Interarrival Times
      4. 3.4 Latency and Tick Size
      5. 3.5 Non-Markovian Nature of Price Changes
      6. 3.6 Market Fragmentation
      7. 3.7 Empirics of pairs trading
      8. 3.8 Bibliography and Selected Readings
    5. 4 Empirical and Statistical Evidence: Activity and Market Quality
      1. 4.1 Daily Volume and Volatility
      2. 4.2 Intraday Activity
        1. 4.2.1 Intraday Volume Patterns
        2. 4.2.2 Intrasecond Volume Patterns
        3. 4.2.3 Price Patterns
      3. 4.3 Trading and Market Quality
        1. 4.3.1 Spreads
        2. 4.3.2 Volatility
        3. 4.3.3 Market Depth and Trade Size
        4. 4.3.4 Price Impact
        5. 4.3.5 Walking the LOB and Permanent Price Impact
      4. 4.4 Messages and Cancellation Activity
      5. 4.5 Hidden Orders
      6. 4.6 Bibliography and Selected Readings
  10. Part II Mathematical Tools
    1. Introduction to Part Two
    2. 5 Stochastic Optimal Control and Stopping
      1. 5.1 Introduction
      2. 5.2 Examples of Control Problems in Finance
        1. 5.2.1 The Merton Problem
        2. 5.2.2 The Optimal Liquidation Problem
        3. 5.2.3 Optimal Limit Order Placement
      3. 5.3 Control for Diffusion Processes
        1. 5.3.1 The Dynamic Programming Principle
        2. 5.3.2 Dynamic Programming Equation / Hamilton-Jacobi-Bellman Equation
        3. 5.3.3 Verification
      4. 5.4 Control for Counting Processes
        1. 5.4.1 The Dynamic Programming Principle
        2. 5.4.2 Dynamic Programming Equation / Hamilton-Jacobi-Bellman Equation
        3. 5.4.3 Combined Diffusion and Jumps
      5. 5.5 Optimal Stopping
        1. 5.5.1 The Dynamic Programming Principle
        2. 5.5.2 Dynamic Programming Equation
      6. 5.6 Combined Stopping and Control
      7. 5.7 Bibliography and Selected Readings
  11. Part III Algorithmic and High-Frequency Trading
    1. Introduction to Part Three
    2. 6 Optimal Execution with Continuous Trading I
      1. 6.1 Introduction
      2. 6.2 The Model
      3. 6.3 Liquidation Without Penalties only Temporary Impact
      4. 6.4 Optimal AcquisitionwithTerminal PenaltyandTemporaryImpact
      5. 6.5 Liquidation with Permanent Price Impact
      6. 6.6 Execution with Exponential Utility Maximiser
      7. 6.7 Non-Linear Temporary Price Impact
      8. 6.8 Bibliography and Selected Readings
      9. 6.9 Exercises
    3. 7 Optimal Execution with Continuous Trading II
      1. 7.1 Introduction
      2. 7.2 Optimal Acquisition with a Price Limiter
      3. 7.3 Incorporating order flow
        1. 7.3.1 Probabilistic Interpretation
      4. 7.4 Optimal Liquidation in Lit and Dark Markets
        1. 7.4.1 Explicit Solution when Dark Pool Executes in Full
      5. 7.5 Bibliography and Selected Readings
      6. 7.6 Exercises
    4. 8 Optimal Execution with Limit and Market Orders
      1. 8.1 Introduction
      2. 8.2 Liquidation with Only Limit Orders
      3. 8.3 Liquidation with Exponential Utility Maximiser
      4. 8.4 Liquidation with Limit and Market Orders
      5. 8.5 Liquidation with Limit and Market Orders Targeting Schedules
      6. 8.6 Bibliography and Selected Readings
      7. 8.7 Exercises
    5. 9 Targeting Volume
      1. 9.1 Introduction
      2. 9.2 Targeting Percentage of Market’s Speed of Trading
        1. 9.2.1 Solving the DPE when targeting rate of trading
        2. 9.2.2 Stochastic Mean-Reverting Trading Rate
        3. 9.2.3 Probabilistic Representation
        4. 9.2.4 Simulations
      3. 9.3 Percentage of Cumulative Volume
        1. 9.3.1 Compound Poisson Model of Volume
        2. 9.3.2 Stochastic Mean-Reverting Volume
        3. 9.3.3 Probabilistic Representation
      4. 9.4 Including Impact of Other Traders
        1. 9.4.1 Probabilistic Representation
        2. 9.4.2 Example: Stochastic Mean-Reverting Volume
      5. 9.5 Utility Maximiser
        1. 9.5.1 Solving the DPE with deterministic volume
      6. 9.6 Bibliography and Selected Readings
      7. 9.7 Exercises
    6. 10 Market Making
      1. 10.1 Introduction
      2. 10.2 Market Making
        1. 10.2.1 Market Making with no Inventory Restrictions
        2. 10.2.2 Market Making At-The-Touch
        3. 10.2.3 Market Making Optimising Volume
      3. 10.3 Utility Maximising Market Maker
      4. 10.4 Market Making with Adverse Selection
        1. 10.4.1 Impact of Market Orders on Midprice
        2. 10.4.2 Short-Term-Alpha and Adverse Selection
      5. 10.5 Bibliography and Selected Readings
      6. 10.6 Exercises
    7. 11 Pairs Trading and Statistical Arbitrage Strategies
      1. 11.1 Introduction
      2. 11.2 Ad Hoc Bands
      3. 11.3 Optimal Band Selection
        1. 11.3.1 The Optimal Exit Problem
        2. 11.3.2 The Optimal Entry Problem
        3. 11.3.3 Double-Sided Optimal Entry-Exit
      4. 11.4 Co-integrated Log Prices with Short-Term-Alpha
        1. 11.4.1 Model Setup
        2. 11.4.2 The Agent’s Optimisation Problem
        3. 11.4.3 Solving the DPE
        4. 11.4.4 Numerical Experiments
      5. 11.5 Bibliography and Selected Readings
    8. 12 Order Imbalance
      1. 12.1 Introduction
      2. 12.2 Intraday Features
        1. 12.2.1 A Markov Chain Model
        2. 12.2.2 Jointly Modelling Market Orders
        3. 12.2.3 Modelling Price Jumps
      3. 12.3 Daily Features
      4. 12.4 Optimal Liquidation
        1. 12.4.1 Optimisation Problem
      5. 12.5 Bibliography and Selected Readings
      6. 12.6 Exercises
  12. Appendix A Stochastic Calculus for Finance
    1. A.1 Diffusion Processes
      1. A.1.1 Brownian Motion
      2. A.1.2 Stochastic Integrals
    2. A.2 Jump Processes
    3. A.3 Doubly Stochastic Poisson Processes
    4. A.4 Feynman-Kac and PDEs
    5. A.5 Bibliography and Selected Readings
  13. Bibliography
  14. Glossary
  15. Subject index