Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Time stamping by stock exchanges

I just finished reading an interesting study of the flash crash in the US on May 6, 2010 by Nanex which is a data feed company which provides high frequency real time trade and quote data for all US equity, option, and futures exchanges (over one million updates per second). The study was published in mid June and linked by Abnormal Returns a week later, but I got around to reading it only today after several blogs talked about it two days ago.

The study claims:

Beginning at 14:42:46, bids from the NYSE started crossing above the National Best Ask prices in about 100 NYSE listed stocks, expanding to over 250 stocks within 2 minutes (See Part 1, Chart 1-b). Detailed inspection indicates NYSE quote prices started lagging quotes from other markets; their bid prices were not dropping fast enough to keep below the other exchange’s falling offer prices. The time stamp on NYSE quotes matched that of other exchange quotes, indicating they were valid and fresh.

With NYSE’s bid above the offer price at other exchanges, HFT systems would attempt to profit from this difference by sending buy orders to other exchanges and sell orders to the NYSE. Hence the NYSE would bear the brunt of the selling pressure for those stocks that were crossed.

Minutes later, trade executions from the NYSE started coming through in many stocks at prices slightly below the National Best Bid, setting new lows for the day. (See Part 1, Chart 2). This is unexpected, the execution prices from the NYSE should have been higher — matching NYSE’s higher bid price, unless the time stamps are not reflecting when quotes and trades actually occurred.

If the quotes sent from the NYSE were stuck in a queue for transmission and time stamped ONLY when exiting the queue, then all data inconsistencies disappear and things make sense. In fact, this very situation occurred on 2 separate occasions at October 30, 2009, and again on January 28, 2010. (See Part 2, Previous Occurrences).

If this is really true, then instead of criticizing only high frequency traders, we must also direct some of the blame at the exchanges which behaved irresponsibly. Why cannot the exchange provide time stamps both of the time that a quote entered the queue and when it exited the queue?

Organizations with none of the self regulatory responsibilities of an exchange do this kind of thing routinely. One of the things that I read today was this study about dissemination of press releases at public websites. Yahoo! Finance provides two timestamps when it reports a press release on its web site – first is the timestamp of the press release itself and the second is the time stamp of when it was published on Yahoo! Finance. By comparing these two time stamps, the study concludes that “the average delay was 83 seconds. The fastest was 24 seconds and the slowest was 237 seconds or almost 4 minutes. The median was 80 seconds.”

It did not require a regulator framing rules for a public website to provide two timestamps in its stories. But perhaps exchanges will do the right thing only if they receive a direction from the regulator. And perhaps the regulator will find itself easily persuaded that this simple thing is too costly, complicated or confusing to implement.


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