30,000 euro prize for the winner and the Goethe University in Frankfurt am Main
The Frankfurt Institute for Risk Management and Regulation awards the third FIRM Research Prize. This year’s winner is Benjamin Clapham, who competed against 14 researchers from Germany and abroad, was chosen for his dissertation on the Integrity and Efficiency of Electronic Securities Markets.
The FIRM Research Prize under the patronage of the Hessian Minister of State for Economics, Energy, Transport and Housing, Tarek Al Wazir, aims to promote authoritative research for a better understanding of risk management and regulation in the financial services sector. A jury of representatives from academia and business selected from papers submitted by summa or magna cum laude doctorates those three that best combine high-level theoretical-conceptual groundwork with empirical research and innovative, practical relevance.
The participants in the final round, Jennifer Betz from the University of Regensburg, Rebekka Buse from the Karlsruhe Institute of Technology and Benjamin Clapham from the Goethe University Frankfurt, presented the most important findings of their work at the FIRM Research Conference on 14 May 2020. The digital conference was chaired by Günter Franke from the University of Constance.
In the end, Benjamin Clapham won over the jury with his work on the integrity and efficiency of electronic securities markets. The jury stated, “Clapham’s careful examination of electronic trading systems has considerably expanded our knowledge of their market microstructure. In particular, he has generated new insights into the effects of trading interruptions and the effects of high-frequency trading.”
Clapham’s supervisor was Peter Gomber, Professor of Business Administration, specifically E-Finance, at the Goethe University Frankfurt.
Clapham explored by the question of how technological developments and market design influence the integrity and efficiency of electronic securities markets. He highlighted three significant developments, including the automated detection of financial market manipulation, the design of mechanisms to ensure orderly trading and the effects of high-frequency trading.
The large number of order updates of algorithmic traders and the increasing number of transactions make it difficult to detect market manipulation. In order to ensure the integrity of securities markets, types of manipulation must be systematised according to their characteristics, and the procedures for their detection must be automated.
Automated procedures allow financial intermediaries and regulatory authorities to detect market manipulations in the immense amounts of data in a resource-saving manner. Clapham develops a classification scheme for all types of financial market manipulation and thus provides a basis for improved market surveillance. A further challenge for market integrity is to ensure continuous price development in continuous trading. High-frequency trading and other algorithmic trading forms can lead to price overreactions, or so-called flash crashes in case of surprising market developments, especially if trading algorithms react inappropriately to sudden market pressure or false information. For this reason, most securities markets have introduced hedging mechanisms to ensure price continuity and at the same time, market liquidity under extreme market conditions. This is achieved by so-called volatility interruptions, which stop continuous trading for a short time by means of an auction phase in the event of sharp price changes. Clapham examines different designs of volatility interruptions and shows how different design parameters influence the effectiveness of hedging mechanisms. His results allow to derive recommendations for the design of hedging mechanisms.
A much-discussed question concerns the magnetic effect of protection mechanisms. Does the anticipation of a likely imminent interruption of continuous trading cause traders to execute their open orders quickly in advance, thereby causing additional volatility and the ultimate triggering of the protection mechanism? While some studies have observed increased trading activity and price changes in advance, Clapham comes to the opposite conclusion.
The paper also examines the effects of high-frequency trading on securities markets. Clapham proves that high-frequency trading reduces the bid-ask spread and accelerates order book replenishment after a liquidity shock. High-frequency trading thus improves the efficiency of securities markets.
The jury found Clapham’s work convincing. “The dissertation makes an important contribution to financial market research by shedding light on relevant aspects relating to the integrity and efficiency of electronic securities markets,” said jury chairman Günter Franke. Exchanges can use the findings in the design of trading rules and operational market surveillance as well as by supervisory authorities for the regulation of trading. The next FIRM research prize will be awarded in 2022.
Author: Prof. Dr. Dr. h. c. Günter Franke (Co-Chairman of the FIRM Advisory Board)