The conventional wisdom in trading dictates that minimising market impact is paramount. However, a closer examination of market dynamics reveals scenarios where influencing prices, rather than avoiding it, can be a strategic advantage. This nuanced outlook is explored through discussions with quant expert Muhle-Karbe, who sheds light on complex trading strategies and their implications.
Market impact, the effect a trade has on an asset’s price, is typically viewed as a cost to be mitigated.Large orders, by their nature, can move prices against the trader, eroding potential profits. Yet, as Muhle-Karbe highlights, this isn’t always the case.
One area where market impact can be intentionally leveraged is in forms of predatory trading. This involves a firm possessing knowledge of a directional trade and actively seeking to exploit it. The infamous case of Jérôme Kerviel at Société Générale, where massive, unwound trades caused significant market disruption, serves as a stark reminder of how large-scale trading can impact prices, albeit often with disastrous consequences for the perpetrator.
Muhle-Karbe’s research, co-authored with Roel Oomen of Deutsche Bank, delves into the intricacies of trading around FX fixings. their study, “A comparison of FX fixing methodologies,” suggests that strategically trading during these crucial windows can actually influence prices in a beneficial way for the trader.This implies that the goal of simply minimising market impact might not always align with optimal trading outcomes in specific contexts.
A interesting example of market impact being a positive outcome, at least in the short term, comes from the analysis of Ponzi funds. Muhle-Karbe references a study by quants at Capital Fund Management that identified a feedback loop in these schemes.
“They look at this feedback loop that if you buy, you push up the price, and you see very good performance,” Muhle-Karbe explains.”Than investors put even more money into the fund, and then you can buy even more. The price goes up even more.And this can continue for a while, until at some point, like any Ponzi scheme, it comes crashing down.”
In these instances, the initial buying pressure, which creates positive market impact, attracts further investment, perpetuating the cycle until its certain collapse.
The conversation also touches upon the recent charges brought by the Indian market regulator against the trading firm Jane Street. While the specifics of the case are complex, it underscores the ongoing scrutiny of trading practices and the potential for market impact to be a central element in regulatory investigations. Muhle-Karbe’s succinct assessment: “it’s complex!”
The discussion around market impact naturally leads to an exploration of trading costs. Muhle-Karbe elaborates on the distinction between linear and impact costs, providing a deeper understanding of the financial implications of executing trades.
The core of Muhle-karbe’s work often involves developing novel methodologies for understanding and managing trading strategies.The applicability of these new approaches across different market conditions and asset classes is a key area of focus.
The podcast also explores existing uses of similar solutions in the market, providing context for the innovative work being done. Looking ahead, Muhle-Karbe outlines future research projects, signalling a continued commitment to pushing the boundaries of quantitative finance.
For those interested in a deeper dive, the full interview is available for listening and download. Future podcasts in the Quantcast series will be uploaded to Risk.net. You can also access all tracks on SoundCloud,
