Has High-Frequency Trading Destabilized Markets?

As reported by Aaron Brown Mar 27, 2012 8:50 am, Minyanville Media, Inc.

Over the last week, we’ve seen a spate of news stories and editorials based on a recent paper by David Bicchetti and Nicolas Maystre of the United Nations Conference on Trade and Development, “The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data” (March 20, 2012). The basic observation of the paper is that correlations between stocks and commodities, especially oil, rose in the second half of 2008 and for the most part have stayed high since. This is true, and well known. It is the conclusion the paper draws from the observation that is newsworthy:

“This result is important for at least two reasons. First, it questions the diversification strategy and portfolio allocation in commodities pursued by financial investors. Second, it shows that, as commodity markets become financialized, they are more prone to external destabilizing effects. In addition, their tendency to deviate from their fundamentals exposed them to sudden and sharp corrections.”

How does a 2008 regime shift in correlations support such strong conclusions about portfolio strategy and market dynamics? Of course the answer is that it doesn’t, but it’s instructive to see where the empirical data leave off and the opinions get inserted.

Read more: http://www.minyanville.com/business-news/markets/articles/aaron-brown-high-frequency-trading-David/3/27/2012/id/40096#ixzz1qKHYA43P

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