Noise has a name: Endogeneity

22 Mar

A recent Swiss study conducted on a number of commodity futures markets has concluded that (no surprise)  price moves are driven by the preceding price moves. The study concluded that since early 2000,” more than out of two price changes in a number of commodity markets followed from an earlier price move”.  The study also surmised that these “price dynamics are partly driven by self-reinforcing mechanisms … which partly reflect the development of algorithmic trading and high frequency trading”. This computer driven, herd mentality has led to a greater degree of endogeneity, which is the movement in price not generated by external information. Thus the trend is your friend, however what the trend is not a friend of is the price discovery process.  Ultimately price is driven by fundamentals, and not by hyperactive computer driven momentum trading activity.

While this study does not bring forth any new information, it does underscore what we have been railing on for years; namely the explosion in speed of execution combined with an explosion in real time “news”.  Endogeneity is out there and it is acted on more quickly and with greater volume than ever before. While this noise may ultimately affect the true price only in the very short run, the fact that a significant number of real world contracts are priced off these noisy prices is somewhat problematic.  We understand that it is not possible to slow the pace of technology ( and thus noise volume),  therefore we have instead chosen to focus our efforts on those specific commodities whose price discovery is driven by real commercial transactions, rather than some code that exists on a server sitting next to one of the exchanges.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: