A former colleague recently pointed out 2 New York Times articles on high speed trading. She wondered whether this technique would add to risks in pension plans. Here are the articles:
Hurrying Into the Next Panic?
New York Times – 2009-07-29
... the latest fashion among investment banks and hedge funds: high-frequency algorithmic trading. On top of an already dangerously influential and morally suspect financial minefield is now being added the unthinking power of the machine.
Stock Traders Find Speed Pays, in Milliseconds
New York Times – 2009-07-24
... high-frequency trading ... is suddenly one of the most talked-about and mysterious forces in the markets.
While the articles are written from a US perspective, the same thing is happening in Canada. One of the biggest players is CIBC, which has grown its volume to over 20% of the market by using this trading technique. As the articles point out, the technique is not without criticism. Individual investors complain that they can't buy or sell fast enough to get current prices. And, what happens if the same technique is applied to bonds? Short term movements could have major effects on prices.
All this creates an interesting dilemma; what is the right price for long term investments (that pension plans hold ) when a sizable portion of the market is only interested in extremely short time frames? It also adds to questions as to whether the efficient market hypothesis is still valid.
A Financial Times article included the following comment: "There is also growing acceptance that basic assumptions must be jettisoned. CFAs no longer believe that markets are efficient - meaning that prices incorporate all known information - or that investment returns follow a normal "bell curve" distribution. The search is on to apply biology and psychology to better understand markets."
Some of these basic assumptions are built into current actuarial models, in particular capital asset models used to assess pension plan risks. Perhaps its time to rethink the fundamentals.