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SUMMARY:Assessing Measures of Order Flow Toxicity and Early Warning Signal
 s for Market Turbulence - Andersen\, T (Northwestern University)
DTSTART:20140923T153000Z
DTEND:20140923T161500Z
UID:TALK54458@talks.cam.ac.uk
CONTACT:Mustapha Amrani
DESCRIPTION:Co-authors: Oleg Bondarenko (University of Illinois at Chicago
 )\, Maria Gonzalez-Perez (CUNEF\, Madrid) \n\nFollowing the much publicize
 d "flash crash" in the U.S. financial markets on May 6\, 2010\, much work 
 has been done in terms of developing reliable warning signals for impendin
 g market stress. However\, this has met with limited success\, except for 
 one measure. The VPIN\, or Volume-synchronized Probability of INformed tra
 ding\, metric is introduced by Easley\, Lopez de Prado and O'Hara (ELO) a
 s a real-time indicator of order flow toxicity. They find the measure usef
 ul in predicting return volatility and conclude it\, indeed\, may help sig
 nal impending market turmoil. The VPIN metric involves decomposing volume 
 into active buys and sells. We use the best-bid-offer (BBO) files from the
  CME Group to construct highly accurate trade classification measures for 
 the E-mini S&P 500 futures contract. Against this benchmark\, the ELO Bulk
  Volume Classification (BVC) scheme is inferior to a standard tick rule ba
 sed on individual transactions. Moreover\, when VPIN is constructed from a
 n accurate classification\, it behaves in a diametrically opposite way to 
 BVC-VPIN. We also find the latter to have forecast power for volatility so
 lely because it generates systematic classification errors that are correl
 ated with trading volume and return volatility. Controlling for trading in
 tensity and volatility\, the BVC-VPIN measure has no incremental predictiv
 e power for future volatility. We conclude that VPIN is not suitable for c
 apturing order flow toxicity or signaling ensuing market turbulence. In an
  extension\, we also explore high-frequency VIX measures as real-time indi
 cators of market stress. We find it critical to control for confounding ef
 fects in the computation of the index. In particular\, during stressful pe
 riods\, when a "fear gauge" is most needed\, VIX is least reliable. As an 
 alternative\, we construct a real-time "corridor" VIX measure. We document
  that this index performs vastly better during stressful episodes like the
  financial crisis and the flash crash.\n
LOCATION:Seminar Room 1\, Newton Institute
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