Posts Tagged ‘Stock Market’

The New York Federal Reserve just posted an entertaining analysis of an “Internet blooper” that struck UAL, the parent company of United Airlines a few years ago. As authors Carlos Carvalho, Nicholas Klagge, and Emanuel Moench note in a blog post:

On September 8, 2008, a six-year-old article about the 2002 bankruptcy of United Airlines’ parent company resurfaced on the Internet and was mistakenly believed to be reporting a new bankruptcy filing by the company. This episode caused the company’s stock price to drop by as much as 76 percent in just a few minutes, before NASDAQ halted trading. After the “news” had been identified as false, the stock price rebounded, but still ended the day 11.2 percent below the previous close. Trading volumes skyrocketed during these extreme price movements. In subsequent days, the stock traded as much as 17 percent below its September 8 closing price, and on September 15 it finally traded above the price level seen just before the false news impacted the market.

In short, it took a week for the stock market to flush the “blooper” out of its system.

They then confirm that result using much more sophisticated techniques that allow them to estimate what UAL’s stock price would have been absent the false news:

For bonus points, they also find that similar, but smaller effects on the stock prices of other major airlines.

ht: Paul Kedrosky.

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The CFTC and SEC staffs are out with their analysis of the May 6 “flash crash.”

Short version: A large trader (identified by the media as Waddell & Reed) initiated a large sell order to be executed based on volume, not time or price. The initial selling boosted trading volumes which prompted the algorithm to sell even faster. That positive feedback then spawned the short-lived crash.

The whole report is worth a skim for the details about market functioning, but if you are pressed for time here’s the key part of the Executive Summary (with my emphasis added and footnotes deleted):

At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader (a mutual fund complex]) initiated a sell program to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.

This large fundamental trader chose to execute this sell program via an automated execution algorithm (“Sell Algorithm”) that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time.

The execution of this sell program resulted in the largest net change in daily position of any trader in the E-Mini since the beginning of the year (from January 1, 2010 through May 6, 2010). Only two single-day sell programs of equal or larger size – one of which was by the same large fundamental trader – were executed in the E-Mini in the 12 months prior to May 6. When executing the previous sell program, this large fundamental trader utilized a combination of manual trading entered over the course of a day and several automated execution algorithms which took into account price, time, and volume. On that occasion it took more than 5 hours for this large trader to execute the first 75,000 contracts of a large sell program.

However, on May 6, when markets were already under stress, the Sell Algorithm chosen by the large trader to only target trading volume, and neither price nor time, executed the sell program extremely rapidly in just 20 minutes.

This sell pressure was initially absorbed by:

• high frequency traders (“HFTs”) and other intermediaries in the futures market;

• fundamental buyers in the futures market; and

• cross-market arbitrageurs who transferred this sell pressure to the equities markets by opportunistically buying E-Mini contracts and simultaneously selling products like SPY, or selling individual equities in the S&P 500 Index.

HFTs and intermediaries were the likely buyers of the initial batch of orders submitted by the Sell Algorithm, and, as a result, these buyers built up temporary long positions. Specifically, HFTs accumulated a net long position of about 3,300 contracts. However, between 2:41 p.m. and 2:44 p.m., HFTs aggressively sold about 2,000 E-Mini contracts in order to reduce their temporary long positions. At the same time, HFTs traded nearly 140,000 E-Mini contracts or over 33% of the total trading volume. This is consistent with the HFTs’ typical practice of trading a very large number of contracts, but not accumulating an aggregate inventory beyond three to four thousand contracts in either direction.

The Sell Algorithm used by the large trader responded to the increased volume by increasing the rate at which it was feeding the orders into the market, even though orders that it already sent to the market were arguably not yet fully absorbed by fundamental buyers or cross-market arbitrageurs. In fact, especially in times of significant volatility, high trading volume is not necessarily a reliable indicator of market liquidity.

What happened next is best described in terms of two liquidity crises – one at the broad index level in the E-Mini, the other with respect to individual stocks.

For more, click on over to the report.

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According to this morning’s Wall Street Journal, the 2000s are on track for a dismal record: the worst performance of U.S. stocks in any decade on record.

According to data from the Yale International Center for Finance, stocks have fallen about 0.5% per year, on average, during the current decade. Unless stocks stage a healthy rally in the next two weeks, the 00s will thus come in behind each of the past 17 decades, including the -0.2% average annual return of the 1930s.

As the article notes, this comparison is partly driven by a “quirk of the calendar, based on when the 10-year period starts and finishes.” For example, stocks fell more in the ten-year period ending in 1938 than they did in the 00s. For a nice year-by-year display, see the WSJ’s graphics (which include the chart to the right).

Let’s hope the 2010s do better.

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The Citigroup pricing anomaly may be in its final days (earlier posts here and here).

Investors must submit their offers to exchange preferred shares for common shares by this Friday (which may require contacting your broker several days earlier). The common shares will then be delivered to investors on July 30.

The pricing gap between the common and preferred shares remains large (about 10% at the close on Monday), but has narrowed as the exchange date has drawn near.

It thus seems an appropriate time to reflect on what, if anything, the Citigroup anomaly illustrates about economics and finance more broadly. Happily, this week’s Economist carries a quote from Dick Thaler (previously quoted in my post about Catherine Zeta-Jones) that summarizes the lesson perfectly:

Mr Thaler concedes that in some ways the events of the past couple of years have strengthened the [Efficient Markets Hypothesis]. The hypothesis has two parts, he says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented.

To me, the Citigroup anomaly illustrates the strength of the “no-free-lunch” part of the EMH, and the limitations of the “price-is-right” part.  (more…)

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Good news on the TARP warrant front today (previous installments here and here).

First off, Reuters reports that:

JPMorgan Chase & Co, seeking to completely extricate itself from a federal bailout program, has asked the government to auction warrants to buy the bank’s stock, after the Treasury Department demanded too high a price for the bank to buy them back.

This is great news. Treasury should be driving a hard bargain. And JP Morgan should allow private investors to compete to buy the warrants — maybe that will allow JPM to use its capital for better purposes. As an economist, I also welcome the opportunity to find out the market price of the warrants, so we can compare it to what all the modelers have been estimating.

Next question: How do I bid? I hope Treasury does this in a way that lets small investors participate, much as they can in Treasury bond auctions.

Meanwhile, the Congressional Oversight Panel released a report on the warrants. The Panel suggests, albeit with major caveats, that some initial warrant repurchases were done too cheaply:


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As I’ve noted in a series of posts (here’s the most recent), there’s an anomaly in the pricing of Citigroup securities. Several issues of Citi’s preferred stock are scheduled to convert into common by the end of the month. Yet the common stock has been trading at a significant premium to the preferred in recent months. As I type this, for example, the common is trading at roughly a 14% premium to the preferred common, even though the conversion is just a few weeks away.

As best I can tell, the only explanation for this pricing anomaly is that Citigroup common stock is very difficult to sell short. So arbitrageurs can’t bid the spread down to levels that would be normal for such a deal.

This anomaly intrigues me for two reasons. First, it appears to be a blatant rejection of strong versions of the efficient markets hypothesis. However, as I will discuss in a later post, the market for Citigroup securities is actually ruthlessly efficient in many ways. As a result, it’s extremely difficult to profit from the anomaly. Sharp financial types have already bid other prices — most notably those for Citi options — to a level where obvious profit opportunities don’t exist.

Second, the anomaly is a big dangling carrot for big-money types to get creative. Markets always try to find ways around imperfections like the limits on short-selling. So I’ve been wondering what creativity would come out of the woodwork. Well, today I got an answer.


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Summary: Both Citigroup and Berkshire Hathaway continue to violate the law of one price.


In previous posts (this is the most recent), I’ve pointed out that there are three ways you can purchase common shares of Citigroup:

Simple: Buy shares of common stock.

Preferred: Buy shares of preferred stock that will convert into common.

Synthetic: Use call and put options to replicate the financial returns of owning common stock.

In a perfect world, these three approaches would give nearly identical prices. That’s the law of one price.

Over the past few months, however, Citi securities have been breaking that law. Investors who have been buying common shares have been significantly overpaying relative to the values implied by the prices of the preferred stock and options.


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