Ups and Downs in the Split-Second World of High-Frequency Finance
Author: Luke Saunders
Posted on Feb 6, 2020
Category: Faculty
Life can be pretty exciting and stressful at the same time for big-time investors dealing with millions in assets. Even a 1% change in prices can be worth tens of thousands of dollars.
Dr. Dinesh Gajurel, a finance professor with UNB’s faculty of management, has a good understanding of how even the smallest of events can have an impact on the market. As one of a very few academics in Canada researching high-frequency finance, he has been applying high-frequency financial econometrics to research jump risk in equity prices.
High-frequency finance looks at stock prices with a very short time interval, sometimes viewing data that has been collected minute-by-minute or even second-by-second. Gajurel uses high-frequency finance to see how stocks respond to very specific occurrences, for example, media coverage of a stock or breaking news.
Investors often consider daily highs and lows in stock prices, but not many of them use high-frequency finance because the data is expensive, difficult to analyze, and requires massive amounts of storage for the terabytes of data required. High-frequency finance makes it possible to examine the jumps in market price that happen in response to external factors such as macroeconomic announcements. These jumps are the focus of Dr. Gajurel’s research.
There is a continuous component to stock growth, where the stock’s price gradually rises over an extended period of time. “This is normal and what we expect to see,” says Gajurel. “What we don’t always expect are these jumps in price, which represent a change (either positive or negative) in price that is significantly greater than the rate of continuous growth. These jumps are an important component of stock volatility, and in some extreme cases can cause a spike in the overall stock market.”
Are these jumps significant and something to be concerned with? “One might think they represent significant volatility, and that they are of great concern to investors,” says Gajurel. “In some cases, it may even convince someone to not invest in a stock.”
This isn’t necessarily an appropriate response, his research suggests, as the jumps in price are idiosyncratic in nature, meaning that they are effectively random and less significant than what one might initially think.
Gajurel hopes his research will help investors make better decisions. Jumps in the market can cause investors to become overzealous and buy or sell quickly, which in the long run will cost them.
“Don't worry about jumps,” he advises. “If you have a diverse stock portfolio they may not matter. A jump is a temporary event.” In other words, if you diversify, then the jumps don’t matter so much and the behaviour of your portfolio becomes more systematic. The market responds to internal and external news, so unless you have insider information you are limited to what has become external.”
Gajurel joined the Faculty of Management in 2017. His research interests include financial crises and contagion, corporate finance, asset pricing and empirical finance. He has published in peer-reviewed journals including the Journal of Banking & Finance, and Economic Systems.
As a sequel to his current project, Gajurel plans to study jumps using high-frequency finance in other markets outside of Canada. If he finds similar results studying markets in the United States, which support the idea that jumps are idiosyncratic in nature regardless of the market, then he will be able to speak very loudly about his results. Stay tuned!