Rational Quantitative Trading in Efficient Markets
55 Pages Posted: 21 Dec 2009 Last revised: 17 Mar 2017
Date Written: April 22, 2014
We present a model of financial markets where quantitative trading emerges endogenously as an automated price-contingent strategy under human discretion. Price-contingent trading has been argued to be inconsistent with (semi-strong) market efficiency. In contrast, we show that price-contingent trading is the profitable equilibrium strategy of a large rational agent whose trading strategy, price-contingent or fundamentals-based, is his source of private information. Even when uninformed about fundamentals he trades a non-zero quantity as a non-monotonic function of order flow: trend-following (re. contrarian) after small (re. large) price changes. In our theory, future order flow is predictable even if returns are not.
Keywords: quantitative trading, market impact, REE, price-contingent trading
JEL Classification: G12, G14, D82
Suggested Citation: Suggested Citation