In his May 5 post, available here, Stanislav Dolgopolov states that the Securities and Exchange Commission’s recent settlement with Citadel “undermines the so-called ‘Berkeley Study’ which concluded that off-exchange market makers can neither profitably engage in data feed arbitrage by ‘filling marketable orders at (or within) the SIP-generated NBBO [National Best Bid and Offer] . . . at stale prices to the disadvantage of retail investors’ nor ‘choose as their pricing benchmark the slower SIP-generated NBBO to boost their performance metrics.’” Mr. Dolgopolov further states that our study “skirted the fact that relevant strategies do not rely on choosing either the SIP or direct data feeds but on cherry-picking individual trades.”
We take strong issue with these statements. We believe them to be plainly inaccurate and to misrepresent what our study concludes.
First, we fully account for cherry-picking. Panel C of Table 5 of our paper displays an upper bound to the profits available to liquidity providers seeking to take advantage of SIP latency. Across more than $3 trillion of SIP-priced trades in the 30 stocks comprising the Dow Jones Industrial Average, the total profits are about $500,000. For trades in non-exchange venues, the amount is $239,241. This is for 10 months of trading. We further estimate these same figures for the entire market over the course of a year. Our estimate for all non-exchange trades is between $2.9 million and $3.5 million. Again, these are gross profits to non-exchange liquidity providers assuming perfect cherry-picking of all marketable orders.
Second, the Citadel settlement covered the period between June 2008 and January 2010. We state clearly, “Nor do our results rule out the possibility that latency arbitrage arising from stale SIP quotes might have been prevalent in the quite recent past (e.g., 2014), for the simple reason that our data are not available until mid-2015.” We additionally state in our conclusion that, “Because our data commence in August 2015, we emphasize that these findings may very well reflect a new market environment in which the HFT strategies depicted in Flash Boys are less prevalent than in the past.”
Finally, the central research question we pose in our paper is whether SIP latency arbitrage strategies are sufficiently profitable that they can explain the current arms race in trading speed. Overall, our analysis suggests SIP reporting latencies generate remarkably little scope for exploiting the informational asymmetries available to subscribers to exchanges’ direct data feeds, regardless of whether trading is targeted at liquidity takers (at issue in Citadel’s settlement) or at liquidity providers (at issue in the recent wave of exchange proposals for speed bumps).
Even though our sample period commences after Citadel ceased using FastFill and SmartProvide, we fail to see how the SEC’s factual findings reveal a trading environment where FastFill and SmartProvide were sufficiently profitable to Citadel to justify large scale investments in trading speed. As Mr. Dolgopolov notes, total trades affected by these strategies were well under 1 percent of Citadel’s trading volume from June 2008 through January 2010. And total disgorged profits were $5 million on a firm with $23 billion in assets as of December 31, 2009. Assuming Citadel was a player in the high-speed arms race during this time-frame, the SEC settlement provides little reason to believe it was because of these two strategies.
Our paper is available here.
This post comes to us from professors Robert P. Bartlett III and Justin McCrary at the University of California, Berkeley – School of Law.