Economists argue that if markets are efficient, trading volume ought to be minimal. Yet what works in principle doesn’t describe the real world. To resolve the paradox, Tom Hyer considers how relative value trading contributes to volume. Using a toy model, he shows that increasing the number of securities does not cause volume to decrease, while the potential for netting out trades within financial institutions is overstated. Finally, he shows that market incompleteness makes market participants trade needlessly on new price information, further increasing volume.
Read the paper here
Tom Hyer studied physics at Rice and at Stanford, where he received a Ph.D before entering the finance industry. During a 20-year career as a derivatives quant, he made several groundbreaking contributions to the field, most importantly in the study of volatility term structures and the pioneering use of underdetermined calibration. However, he was primarily distinguished as a “practitioner’s practitioner,” focused on the robust implementation and production use of complex models for complex derivatives. His 2010 book Derivatives Algorithms (World Scientific; 2nd edition, 2015) remains the only advanced treatment of coding for financial products. Hyer is now Chief Risk Officer at Akuna Capital.