(Bloomberg) — The Jamaican sprinter Usain Bolts world record time in the 100-meter dash is 9.58 seconds. But what if it took him 958 seconds to get down the track?
Thats basically the magnitude of the difference in time it can take orders to buy and sell to move through a single electronic trading platform, and the random variance itself can cause volatility in stock prices, according to a study by Andrei Kirilenko, professor at Massachusetts Institute of Technology and former chief economist for the Commodity Futures Trading Commission. (Not to be confused with the basketball player of the same name, who was traded to the lowly 76ers this season but never actually showed up to play.)
One electronic platform he studied can take as little as 800 microseconds (or millionths of a second) to process a trading message — or as much 100 times longer. Shorter intervals, defined on Wall Street as lower latency, are a selling point for exchange executives who nowadays spend most of their time pitching their systems to high-frequency traders.
So when an exchange brags that its latency averages out to 3 milliseconds, its not very meaningful, given the disparity, according to Kirilenko. He led the investigation of the so- called Flash Crash in 2010, when the Dow Jones Industrial Average plunged almost 1,000 points before recovering much of the loss.
Why should we care? It matters because when a venues latency becomes extremely large or especially volatile, alarms will go off inside the traders systems, according to the report co-authored by Guilherme Lamacie of Brazilian exchange operator BM&F Bovespa.
Reactions to those alarms, either by humans or software, can result in changes in trading behavior, including exiting existing positions, trading much less or waiting out the perceived market turbulence, the report said. As a result, the random variable of latency has a strong predictive power over volatility.
Unique Signal
Prices serve as a unique signal that everyone can look at and make decisions, Kirilenko told Bloombergs Annabelle Ju. For some who need to get in and out of the market fast, this matters. Its not good to be second in line.
Regulators around the world have taken note of the importance of low latency and the arms race its inspired among high-speed traders, not to mention the impact on slower ones. However, proposals to slow trading down are misguided and could result in added complexity as well as extra costs to the investors theyre meant to help, according to Kirilenko and Lamacie.
Instead, the study recommends that exchanges and other trading platforms be required to report characteristics of latency — measurements of every order submission, cancellation, modification or execution can be measured to the microsecond — so that any information of value can be discovered by all. Indeed, the authors contend, tradable financial instruments based on latency could even be created.
If volatility can be traded, so can latency, the study said.
What chance do Kirilenkos latency instruments actually have of being traded one day? Who knows. But one thing is for sure: They stand a better chance of being traded than the 76ers have of trading the other Andrei Kirilenk
