ETFs, High-Frequency Trading and Flash Crashes

Posted: 21 Jul 2016 Last revised: 14 Nov 2016

See all articles by Irene Aldridge

Irene Aldridge

AbleMarkets.com; Cornell University; BigDataFinance.org; ABLE Alpha Trading, LTD

Date Written: July 18, 2016

Abstract

In this article, the author presents a model of distributional properties of returns on financial instruments tied to ETFs via high-frequency statistical arbitrage. As the author’s model shows, the securities subject to an ETF arbitrage exhibit a well-defined behavior, largely dependent on the behavior of other securities comprising the ETF. The model can be used to improve risk management of long-term portfolios, and, in particular, allow hedging of flash crashes. Furthermore, the analysis shows that in the electronic markets that allow high-frequency trading, the intraday downward volatility for the underlying securities comprising an ETF is bounded from below, and, is, as a result, less extreme than that of securities not included in any ETFs. Also, in the markets where the high-frequency trading is restricted, downward price movements are more extreme than in the markets where high-frequency trading is present.

Keywords: Portfolio Management, Volatility, Risk Management, Risk Measurement, ETFs, High-Frequency Trading, Flash Crashes, Mathematical Models

JEL Classification: C01, C02, D01, D44, D84, D81, G11, G12, G15, G18

Suggested Citation

Aldridge, Irene, ETFs, High-Frequency Trading and Flash Crashes (July 18, 2016). Journal of Portfolio Management, Fall 2016, Vol. 43, No. 1: pp. 17-28. Available at SSRN: https://ssrn.com/abstract=2811262

Irene Aldridge (Contact Author)

AbleMarkets.com ( email )

New York, NY 10128
United States

HOME PAGE: http://www.AbleMarkets.com

Cornell University ( email )

Ithaca, NY 14853
United States

BigDataFinance.org ( email )

United States

ABLE Alpha Trading, LTD ( email )

New York, NY 10004
United States

HOME PAGE: http://www.ablealpha.com

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