Tag Archives: Financial market

February 19, 2012 · 02:23

Speed Traders Are Approaching Speed of Light – And Beyond

As you read this, a gigantic fiber optic cable is being put in place, right across the Atlantic, from the UK to  the US, so that high speed trading robots can save 5 millisecond on their communications. At the same time a new computer chip is being launched that are able to prepare trades in 740 nanosecond. Faster than you are able to blink your eye, faster than you are able to think…

“The downside of society’s continuing drive toward larger, faster, and more interconnected socio-technical systems such as global financial markets, is that future catastrophes may be less easy to forsee and manage –  as witnessed by the recent emergence of financial flash-crashes.”

Neil Johnson

With computers able to work faster than the speed of light, we are giving away the power to control our own lives. No human brain is able to think faster than 1000 nanoseconds, US researchers points out in a new paper as they reveal signs of the financial markets transforming into a machine-dominated phase that eventually will end in disaster.

Here’s a summary of what the paper says:

  • “Society’s drive toward ever faster socio-technical systems, means that there is an urgent need to understand the threat from ‘black swan’ extreme events that might emerge.”
  • “On 6 May 2010, it took just five minutes for a spontaneous mix of human and machine interactions in the global trading cyberspace to generate an unprecedented system-wide Flash Crash. However, little is known about what lies ahead in the crucial sub-second regime where humans become unable to respond or intervene sufficiently quickly.”
  • “Here we analyze a set of 18,520 ultrafast black swan events that we have uncovered in stock-price movements between 2006 and 2011.”
  • “We provide empirical evidence for, and an accompanying theory of, an abrupt system-wide transition from a mixed human-machine phase to a new all-machine phase characterized by frequent black swan events with ultrafast durations (<650ms for crashes, <950ms for spikes).”
  • “Our theory quantifies the systemic fluctuations in these two distinct phases in terms of the diversity of the system’s internal ecology and the amount of global information being processed.”
  • “Our finding that the ten most susceptible entities are major international banks, hints at a hidden relationship between these ultrafast ‘fractures’ and the slow ‘breaking’ of the global financial system post-2006.”
  • “More generally, our work provides tools to help predict and mitigate the systemic risk developing in any complex socio-technical system that attempts to operate at, or beyond, the limits of human response times.”

The paper is authored by a team of physicists, engineers and industry data experts, led by Neil Johnson from University of Miami.

It is charmingly entitled:  “Financial Black Swans Driven by Ultrafast Machine Ecology” 

The scientist describes the developments as “approaching singularity.” 

It is plainly the point in time from when computers are able to calculate, react and perform faster than any human being.

And it’s a point we obviously are about to reach:

“… a new dedicated transatlantic cable is being built just to shave 5 milliseconds off transatlantic communication times between US and UK traders, while a new purpose-built chip iX-eCute is being launched which prepares trades in 740 nanoseconds …”

Johnson and his colleagues ask the question of whether today’s high-frequency markets are moving toward a boundary of speed where human intervention and control is effectively impossible:

“The downside of society’s continuing drive toward larger, faster, and more interconnected socio-technical systems such as global financial markets, is that future catastrophes may be less easy to forsee and manage –  as witnessed by the recent emergence of financial flash-crashes. In traditional human-machine systems, real-time human intervention may be possible if the undesired changes occur within typical human reaction times. However,… in many areas of human activity, the quickest that someone can notice such a cue and physically react, is approximately 1000 milliseconds (1 second).”

www.betabeat.com writes:

“Notwithstanding this biophysical limitation, the strategic advantage to a financial company of having a faster system than its competitors is currently driving a billion-dollar technological arms race to reduce communication and computational operating times down toward the physical limits of the speed of light – orders of magnitude below human response times.”

Physics of Finance and blogger, Mark Buchanan, writes:  

” This just illustrates the technological arms race underway as firms try to out-compete each other to gain an edge through speed. None of the players in this market worries too much about what this arms race might mean for the longer term systemic stability of market; it’s just race ahead and hope for the best.”

So, to summarize: We now have machines that are moving big chunks of money around faster than our eyes can blink, faster than our tiny brains can comprehend, with the potential to cause crashes that are so lightening-quick they can neither be anticipated nor corrected before causing systemic trauma – because traders are still really fast at panicking.

Just great!

Here are some other highlights – enjoy:

“… our data set shows a far greater tendency for these financial fractures to occur, within a given duration time-window, as we move to smaller timescales, e.g. 100-200 ms has approximately ten times more than 900-1000 ms.”

“The presence of humans actively trading — and hence their ‘free will’ together with the myriad ways in which they can manually override algorithms — means that the effective number (i.e. α > 1). Moreover α > 1 implies m is large, hence there are more pieces of information available which suggests longer timescales…  in this α > 1 regime, the average number of agents per strategy is less than 1, hence any crowding effects due to agents coincidentally using the same strategy will be small. This lack of crowding leads our model to predict that any large price movements arising for α > 1 will be rare and take place over a longer duration.”

“Our model therefore predicts a rapidly increasing number of ultrafast black swan events as we move to smaller α and hence smaller subsecond timescales – as observed in our data.”

Download paper.

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September 15, 2011 · 14:02

Goodbye Eurobonds! (Or Hello?)

It could have been a part of a possible solution to prevent a collapse of the European monetary system – the eurobonds. But as pointed out in numerous articles here at EconoTwist’s, it is not possible for the euro zone governments to agree on anything fundamental as long as there’s no real union of Europe. Some of you may be familiar with the term “Tragedy of the Commons” – the story about the eurobonds turns out to be yet another illustration of this human imperfection.

“Eurobonds are an appealing concept in theory, but cannot be implemented in today’s Europe characterized by a large debt overhang, and the absence of a credible system to enforce even the weak elements of economic governance we have now.”

Daniel Gros

“The current upheaval in financial markets has reinforced the voice of those who call for the introduction of Eurobonds as the only way to end the euro debt crisis.  However, August 2011 might well be remembered as the month during which the idea of eurobonds was murdered by the Italian political system,” Director of the think tank CEPS in Brussels, Daniel Gros, writes in commentary article at www.eurointelligence.com.

Well, if the Italians didn’t do it, somebody else would have…

The idea of introducing a new financial instrument – another way to issue more sovereign debt – might have provided the European banks with another temporary source of income.

But that’s about it…

Besides, the practical issues related to an implementation of such bonds is not possible to solve in today’s political environment in Europe.

Maybe the eurobonds belongs to the future. But for now it’s just another nice thought – much like the very basic idea of the “United States of Europe“.

Director of the think tank CEPS in Brussels, Daniel Gros, does a pretty good job explaining the details in the following article, syndicated by www.eurointelligence.com:

The basic facts of the Italian drama are well-known: in early August, when interest rates on Italian government debt soared and the Italian banking system got under pressure, the ECB started buying Italian debt on the understanding that Italy would quickly adopt a multiannual program to reduce its deficit and promote growth.

This understanding was made explicit in a letter send by the present and future presidents of the ECB to the Italian government.

Initially it appeared the country would react in a matter of days. 

But as the pressure from financial markets abated somewhat the government, under pressure from different parts of the ruling coalition, continued to change its mind on what taxes to increase and what expenditure to cut.

Growth enhancing measures went out of the window and the revenues assumptions underpinning the budgets plans became ever more shaky.

The ECB had thus little choice, but to stop buying Italian bonds, whose yields then soared again.

This finally convinced the Government that it had no choice but to toughen the budget again so as to ensure renewed support by the ECB.

Given this experience it is instructive to speculate what might have happened if Eurobonds had already been implemented by early 2011.

What variant of Eurobonds?

Imagine first, that Italy could still have issued substantial amounts of Eurobonds.

In this case the Italian government would have continued to defend its position that Italy’s fundament position was sound (relatively low deficit and strong domestic savings); and that there was therefore no need to implement a strong fiscal adjustment now.

There are always valid arguments to delay action. 

The Italian government might even find a Nobel prize laureate who would support the notion that any attempt to implement a fiscal adjustment now would be self-defeating because it would depress demand so much that in the end the deficit would not improve.

Defenders of Eurobonds would say that ‘the EU’ (i.e. the eurogroup of finance ministers) might have imposed the adjustment anyway.

This is possible, but not likely, because in the absence of a clear market signal the need for action can always be disputed.

But what would have happened even if “the EU” had ordered Italy to do a fiscal adjustment now?

It is quite possible that the government might not have been able to find a majority in Parliament.

What then? Fines?  Why would the prospect of fines, which only embarrass the government, suddenly produce a consensus on reforms?

What if Italy had already exhausted its allocation of Eurobonds (or the EU had not allowed it to issue any more)?

In this case the price of all the Italian “non eurobonds,” i.e. those Italian bonds not guaranteed by its partners, would have tanked even more as financial markets would perceive that these bonds would be first in line in case of trouble.

Total Italian government debt is about 1.800 billion euro.  If one assumes that eurobonds might have been issued for about one half of this one would still be left with 900 billion euro, enough to drive large parts of the EU’s banking system into insolvency should the country default on it.

With or without Eurobonds, the ECB would have faced the same unpleasant choice: intervene in the secondary market or risk a collapse of the European banking system.

The Italian “summer theatre” of 2011 illustrates once more that the problem is not that a government will openly defy its euro zone partners, but rather that its parliament is so divided that the government cannot push through the measures that are required.

Greece has already shown that countries default not because they deliberately choose to, but because society at large is so divided that it is impossible to make the necessary adjustment to ensure orderly debt service.

This leads to the final thought: What would happen to the “eurobonds” issued by a country which does not comply with conditions set in Brussels or Frankfurt? 

Would financial markets really believe that Germany would honour its guarantee if the country concerned had not abided by its own obligations?

The German government might well argue that the country had destroyed the essential elements (‘Geschäftsgrundlage’ in German) for eurobonds.

Depending on the exact legal basis for Eurobonds, i.e. what jurisdiction would apply, this uncertainly could very well lead to significant yield differentials between the Eurobonds issued by different member states.

Eurobonds are an appealing concept in theory, but cannot be implemented in today’s Europe characterized by a large debt overhang, and the absence of a credible system to enforce even the weak elements of economic governance we have now.

.

Daniel Gros is Director of the think tank CEPS in Brussels.

 

LATEST: EU Commission ready to announce eurobond proposal 

So, the confusion continues…

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April 27, 2011 · 00:04

Eurogroup Chief Wants Secret Debates on Monetary Policy

This is the kinda stuff that really worries me, and underline my argument about most politicians being out of touch with the today’s financial reality, living in an imaginary world where the practice and traditions of the good old times are hailed as the only, undisputable, truth.

“Monetary policy is a serious issue. We should discuss this in secret, in the Eurogroup.”

Jean-Claude Juncker

Damn right its serious business! And if Mr. Juncer believes for a second that keeping things secret in today’s electronic information-driven markets is the best way to go, he is dangerously mistaken.

Imagine how the markets would react if some of the secrets leaked out, let’s say; as a result of a hackers attack?

And if the Eurogroup chief is not aware of it yet; rumors may create far more volatility than hard cold facts.

And just the very idea of more secrecy in today’s financial markets, is one of the biggest threats to the overall financial stability. Lack of trust and confidence.

Anyway, this is what the EUobsever.com reports:

Eurozone economic policies should only be conducted in “dark secret rooms”, to prevent dangerous movements in financial markets, the Eurogroup chief said on Wednesday (20 April), adding that he had often lied in his career to prevent the spread of rumours that could feed speculation.

As exists in the case of monetary policy, all economic decisions should now be discussed behind closed doors, he said

“Monetary policy is a serious issue. We should discuss this in secret, in the Eurogroup,” Jean-Claude Juncker said at a Brussels conference on economic governance organised by the European Movement, an organisation that promotes European integration, referring to matters already long since outsourced from national parliaments to independent central banks.

“The same applies to economic and monetary policies in the Union. If we indicate possible decisions, we are fuelling speculations on the financial markets and we are throwing in misery mainly the people we are trying to safeguard from this.”

“I’m ready to be insulted as being insufficiently democratic, but I want to be serious,” he said.

Under his line of reasoning, ministers and EU leaders who discuss financial matters in public put “millions of people at risk” due to wild swings in financial markets produced by their public commentary.

“I am for secret, dark debates,” he quipped.

“There is insufficient awareness at the European level when it comes to these issues, because each of us wants to show his domestic public that he’s the greatest guy under the sky,” Juncker noted.

Having served as finance minister and then premier of Luxembourg for the past 22 years, Juncker pointed out that over the course of his career, despite his Catholic upbringing, he often “had to lie” in order not to feed rumours.

A conference-goer suggested that removing the secrecy in EU meetings could prevent markets from moving on rumour and speculations, Juncker said that could not be done because ministers and EU leaders need time to reach decisions.

“Actions on the financial markets are taking place in real-time. We don’t always agree at each and every debate on monetary policy, but meanwhile markets are reacting.”

Juncker also used the occasion to give his endorsement to changes the European Parliament has made to EU economic governance legislation, amendments that tighten the European Commission‘s role as fiscal-policy policeman, watching over member-state economic decisions.

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