Did Trading Bots Resurrect the CAPM?

Abstract

We document a significant, up to 10-fold increase in the intra-day correlation of firm-specific and market returns over the last decade. This surge in the intra-day correlation of returns coincided with the advent of electronic, automated trading in U.S. markets. Using changes to the S&P500 index, we establish evidence of a causal relationship. When firms are included in this major index, they enter the radar of high frequency arbitrageurs and market making algorithmic traders. These trading robots, who monitor prices in major securities closely and continuously, increase their quoting activities significantly and cause individual stocks’ returns to align more closely with the market.

Keywords: automated quoting, high-frequency trading, machine learning, market microstructure, systematic risk, causal random forests

JEL Classification: G10, G14, G12