Academic paper questions HFT role in volatility and correlation

Joseph Saluzzi ( and Sal L. Arnuk ( are co-heads of the equity trading desk at Themis Trading LLC (, an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.


Chances are that if you went to business school or even just took some business courses as an undergraduate, you probably forked over a few bucks for a Frank Fabozzi textbook. Professor Fabozzi has written many books on finance and is highly respected in the academic community. To our surprise, we recently came across a paper titled “High Frequency Trading:Methodologies and Market Impact” (Read Paper Here) which was co-authored by Professor Fabozzi.

We must admit that the first thought that came to mind was that the HFT lobby has pulled another Mishkin and gotten an academic to write a paper for them. Before even reading these types of papers, we first always check the references section to see what type of work the author will be referencing. Here is where our anxiety level started to climb. In the reference section, we saw names like Aldridge, Angel, Brogaard and Hendershott. Missing from the reference section was anything published by Arnuk and Saluzzi or Kaufman or R.T. Leuchtkafer. We were thinking now that this paper had all the makings of a pro-HFT hit piece.

Here is a line from the conclusion of the paper: “Empirical analysis has shown that the presence of HFTers has improved market quality in terms of lowering the cost of trading, adding liquidity, and reducing the bid-ask spreads.” Oh boy, not the old it shrinks spreads and adds liquidity argument again. But wait a second, the next line goes on to say: “Given the short-time nature of HFT and the fact that positions are typically not carried overnight, the potential for market manipulation and for the creation of bubbles and other nefarious market effects seems to be modest.” Did he just say “modest”? The typical HFT hit piece would say that market manipulation is not possible and there is no nefarious behavior and say HFT is just market making evolved.

We read on: “The problems posed by HFT are more of the domain of model or system breakdown or cascading (typically downward) price movements as HFTers withdraw liquidity from the markets.” Whoa..this can’t be an academic paper. It is actually questioning whether or not HFT withdraws liquidity from the market. Why haven’t we read any articles that have quoted from this paper? Maybe the HFT community and their enablers were hoping we didn’t see this paper.

The paper is actually a well balance report which sometimes argues in favor but also questions many HFT practices. The beginning section talks about what the authors refer to as HFD or high frequency data and UHFD or ultra high-frequency data. They state: “HFD and UHFD might be considered the fuel of HFT.” In other words, without the exchange supplied highly enriched private data feeds, there would be no HFT.

The latter section of the paper goes into the pros and cons of HFT. The authors quote from a few different professors and reveal some startling quotes that we haven’t seen before:

Professor Voev: “There is recent evidence that HFT is leading to more correlation, a fact that has serious implications for diversification. This is making it more difficult to diversify with index tracking or exchange-traded funds. There are now thousands of algos trading indexes, moving prices. Is price momentum dominated by traders trading indexes?”

Professor Bauwens: “My conjecture is that HFT has in most cases increased the speed at at which prices adjust to reflect new information; thus, it has led to increased efficiency. However, it has also been noted that correlation between intraday returns of stocks has increased without apparently much reason, and this may be caused by HFT driven by econometric models disconnected from fundamentals.”

Professor Voev: “We now have faster channels of market fear, uncertainty. Is HFT causing this or is it just a question of faster channels, with HFT facilitating fast channeling of emotions, fear? In normal times, HFT brings smoother adjustment to new levels versus discrete moves which are more volatile. But in more extreme circumstances, it can lead to spikes in volatility.”

There is much more in this paper than we can’t cover in this blog post. If you get a chance, give it a read. And the good thing is you don’t have to pay for Fabozzi for the textbook

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