Investigating Financial Fraud in High Frequency Trading: Context and Drivers
33 Pages Posted: 20 Dec 2011 Last revised: 17 Sep 2014
Date Written: December 20, 2011
Financial markets are very important components of the world economy and at the same time, their structure has changed substantially over the last thirty years primarily due to the use of information and communication technologies. Market monitoring and surveillance is an important process to the financial markets in order to ensure that market rules and policies are met as well as to detect any act or attempt of manipulation.
Recently, a new kind of trading has emerged, High Frequency Trading, which allows traders to place and execute orders within milliseconds via computerised programs. It is still unclear whether existing market systems are capable of carrying out effective monitoring and detecting inconsistencies in trades at such high speeds. This paper provides an initial approach to firstly, develop a broad understanding of financial markets, financial fraud and the role of high frequency trading and secondly, to discuss and exemplify market monitoring challenges in the context of high frequency trading.
Since this is such a recent phenomenon with no confirmed cases of market manipulation to the best of our knowledge, the paper attempts to answer whether there are certain conditions that could benefit market manipulators. The paper employs the use of business intelligence techniques to analyse historical data and identify what types of indicators could be employed for monitoring purposes. The initial analysis shows indications of possible violations of the regulations that were not dealt with and that under a very high volume of orders scenario, it is possible that the market systems are not able to cope. Finally the paper introduces the “zero duration oxymoron” phenomenon where if the baseline price for the calculation of the compliance of the quotation standards rule is not uniform across exchanges, the same quote could be considered valid in one exchange and not valid in another.
Keywords: financial markets, high frequency trading, financial fraud, business intelligence, zero-duration quotes, zero duration oxymoron
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