Algorithmic Trading, Stochastic Control, and Mutually-Exciting Processes

SIAM Review, Forthcoming

36 Pages Posted: 8 Jan 2019

See all articles by Álvaro Cartea

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sebastian Jaimungal

University of Toronto - Department of Statistics

Jason Ricci

University of Toronto, Department of Statistics

Date Written: December 24, 2018

Abstract

We develop a high frequency (HF) trading strategy where the HF trader uses her superior speed to process information and to post limit sell and buy orders. By introducing a multifactor mutually exciting process we allow for feedback effects in market buy and sell orders and the shape of the limit order book (LOB). Our model accounts for arrival of market orders that influence activity, trigger one-sided and two-sided clustering of trades, and induce temporary changes in the shape of the LOB. We also model the impact that market orders have on the short-term drift of the midprice (short-term-alpha). We show that HF traders who do not include predictors of short-term-alpha in their strategies are driven out of the market because they are adversely selected by better informed traders and because they are not able to profit from directional strategies.

Keywords: Algorithmic Trading, High Frequency Trading, Short Term Alpha, Adverse Selection, Self-Exciting Processes, Hawkes processes

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian and Ricci, Jason, Algorithmic Trading, Stochastic Control, and Mutually-Exciting Processes (December 24, 2018). SIAM Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3306158

Álvaro Cartea (Contact Author)

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Sebastian Jaimungal

University of Toronto - Department of Statistics ( email )

100 St. George St.
Toronto, Ontario M5S 3G3
Canada

HOME PAGE: http://http:/sebastian.statistics.utoronto.ca

Jason Ricci

University of Toronto, Department of Statistics ( email )

Toronto, Ontario M5S 3G8
Canada

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