Algorithmic Trading and Benchmarks: A study of the Swedish market

Abstract: Algorithmic trading has grown in popularity over the last few years. The large financial centres of the world are leading the development of this new kind of trading. We investigate the development of algorithmic trading in Stockholm by conducting interviews with major institutions on the financial market. The aim being to give a picture of what current practice is like in the Stockholm institutional equities market. The trades done via algorithms are evaluated against benchmarks. Our perception is that VWAP is the most common benchmark in the Stockholm financial market place and therefore also in Sweden. To analyse the risks inherent in a guaranteed VWAP trade we investigate if there are factors that affect the relative spread between VWAP and TWAP, the proxy we use for the risk in a VWAP trade from the sell side trading desks perspective. We use common risk measures as well as micro factors in each constituent of the OMXS30 index together with the index itself to be able to identify both idiosyncratic and market risk. The initial economic reasoning is that over a longer period there should be no difference between the two benchmarks, VWAP and TWAP. This holds true for the majority of the dependent variables studied but in 11 out of 30 cases there seems to be a statistically significant difference. This is something we ascribe to our specific data sample. We find that for most constituents there are some significant variables that contribute to an idiosyncratic risk. However, on a portfolio or index level this risk might be different. This means that the pricing of a VWAP trade should be done individually with respect to the different levels of risk. A direct affect of this, for a sell side trading desk, would be to charge individual commissions for each stock dependant on its loadings of risk factors.