Parameter Analysis of the VPIN (Volume Synchronized Probability of Informed Trading) Metric

Constantin Zopounidis, Editor. Quantitative Financial Risk Management: Theory and Practice. 2014. Wiley.

26 Pages Posted: 21 Apr 2014

See all articles by Jung Heon Song

Jung Heon Song

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab)

Kesheng Wu

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab)

Horst Simon

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab)

Date Written: March 1, 2014

Abstract

VPIN (Volume synchronized Probability of Informed trading) is a leading indicator of liquidity-induced volatility. It is best known for having produced a signal more than hours before the Flash Crash of 2010. On that day, the market saw the biggest one-day point decline in the Dow Jones Industrial Average, which culminated to the market value of $1 trillion disappearing, but only to recover those losses twenty minutes later (Lauricella 2010).

The computation of VPIN requires the user to set up a handful of free parameters. The values of these parameters significantly affect the effectiveness of VPIN as measured by the false positive rate (FPR). An earlier publication reported that a brute-force search of simple parameter combinations yielded a number of parameter combinations with FPR of 7%. This work is a systematic attempt to find an optimal parameter set using an optimization package, NOMAD (Nonlinear Optimization by Mesh Adaptive Direct Search) by Audet, le digabel, and tribes (2009) and le digabel (2011). We have implemented a number of techniques to reduce the computation time with NOMAD. Tests show that we can reduce the FPR to only 2%.

To better understand the parameter choices, we have conducted a series of sensitivity analysis via uncertainty quantification on the parameter spaces using UQTK (Uncertainty Quantification Toolkit). Results have shown dominance of 2 parameters in the computation of FPR. Using the outputs from NOMAD optimization and sensitivity analysis, We recommend A range of values for each of the free parameters that perform well on a large set of futures trading records.

Keywords: VPIN, volatility, sensitivity analysis, nonlinear optimization

JEL Classification: C44, C22, C61

Suggested Citation

Song, Jung Heon and Wu, Kesheng and Simon, Horst, Parameter Analysis of the VPIN (Volume Synchronized Probability of Informed Trading) Metric (March 1, 2014). Constantin Zopounidis, Editor. Quantitative Financial Risk Management: Theory and Practice. 2014. Wiley., Available at SSRN: https://ssrn.com/abstract=2427086 or http://dx.doi.org/10.2139/ssrn.2427086

Jung Heon Song

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab) ( email )

1 Cyclotron Road
Berkeley, CA 94720
United States

Kesheng Wu (Contact Author)

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab) ( email )

1 Cyclotron Road
Berkeley, CA 94720
United States

Horst Simon

University of California, Berkeley - Lawrence Berkeley National Laboratory (Berkeley Lab) ( email )

1 Cyclotron Road
Berkeley, CA 94720
United States

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