Rational Quantitative Trading in Efficient Markets

55 Pages Posted: 21 Dec 2009 Last revised: 17 Mar 2017

See all articles by Stefano Rossi

Stefano Rossi

Bocconi University; Krannert School of Management; Centre for Economic Policy Research (CEPR)

Katrin Tinn

Imperial College London - Accounting, Finance, and Macroeconomics

Date Written: April 22, 2014

Abstract

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

Rossi, Stefano and Tinn, Katrin, Rational Quantitative Trading in Efficient Markets (April 22, 2014). Available at SSRN: https://ssrn.com/abstract=1525403 or http://dx.doi.org/10.2139/ssrn.1525403

Stefano Rossi

Bocconi University ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Krannert School of Management ( email )

West Lafayette, IN 47907-1310
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Katrin Tinn (Contact Author)

Imperial College London - Accounting, Finance, and Macroeconomics ( email )

South Kensington campus
London SW7 2AZ
United Kingdom

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