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Article

The Exchange of Flow Toxicity

David Easley, Marcos M. López de Prado and Maureen O’Hara
The Journal of Trading Spring 2011, 6 (2) 8-13; DOI: https://doi.org/10.3905/jot.2011.6.2.008
David Easley
is the Scarborough Professor and the Donald C. Opatrny Chair in the Department of Economics at Cornell University in Ithaca, NY.
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  • For correspondence: dae3@cornell.edu
Marcos M. López de Prado
is the head of High Frequency Futures at Tudor Investment Corp. and is a postdoctoral fellow of RCC at Harvard University in Cambridge, MA.
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  • For correspondence: marcos.lopezdeprado@tudor.com
Maureen O’Hara
is the Robert W. Purcell Professor of Finance at Cornell University in Ithaca, NY.
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  • For correspondence: mo19@cornell.edu
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Abstract

Flow toxicity can be measured in terms of the probability that a liquidity provider is adversely selected by informed traders. In previous papers the authors introduced the concept of Volume-synchronized Probability of Informed Trading (the VPIN* metric) and provided a robust estimation procedure. In this study, they discuss the asymmetric impact that an incorrect estimation of the VPIN metric has on a market maker’s performance. This asymmetry may be part of the explanation for the evaporation of liquidity witnessed on May 6th 2010. To mitigate that undesirable behavior, they present the specifications of a VPIN contract, which could be used to hedge against the risk of higher than expected levels of toxicity, as well as to monitor such risk. Among other applications, it would also work as an execution benchmark and a price discovery mechanism, since it allows for the externalization of market participants’ views of future toxicity.

  • Copyright © 2011 Tudor Investment Corp. All rights reserved. Not to be reproduced or redistributed without permission.
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The Journal of Trading: 6 (2)
The Journal of Trading
Vol. 6, Issue 2
Spring 2011
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The Exchange of Flow Toxicity
David Easley, Marcos M. López de Prado, Maureen O’Hara
The Journal of Trading Mar 2011, 6 (2) 8-13; DOI: 10.3905/jot.2011.6.2.008

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The Exchange of Flow Toxicity
David Easley, Marcos M. López de Prado, Maureen O’Hara
The Journal of Trading Mar 2011, 6 (2) 8-13; DOI: 10.3905/jot.2011.6.2.008
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  • Article
    • Abstract
    • THE BID-ASK SPREAD AS A FUNCTION OF PIN
    • THE MARKET MAKER’S ASYMMETRIC PAYOFF DILEMMA
    • THE FVPIN CONTRACT
    • POTENTIAL USES OF THE FVPIN CONTRACT
    • CONTRACT SPECIFICATIONS
    • CONCLUSIONS
    • ENDNOTES
    • REFERENCES
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