Largest global study reveals benefits, systemic risks of computer-based trading

A new UK government research project, undertaken by an international team of researchers including experts from the University of Bristol, into the advantages and risks of computer-based trading in financial markets has shown it to have beneficial effects but warned of the risks of greater instability.

Technological advances have meant that computer-based trading, which enable computer algorithms - automated systems for buying and selling securities - rather than humans to drive high-speed stock trades, now represent the majority of quotes and trades in financial markets.

The two-year study, involving experts from more than 20 countries, aimed to generate evidence on the links between computer-based trading and liquidity, volatility, the likelihood of market crashes and market manipulation.

Evidence from the report, described by the New York Times as "the most comprehensive effort to date to understand the computerised trading firms that have come to dominate the financial markets and generate anxiety among regulators and investors", suggest that computer-based trading has several beneficial effects on markets.

Results show it helps to maintain liquidity, reduce transaction costs and increase the efficiency of market prices but finds no evidence to suggest it has led to increased volatility or abuse of the market. However, it warns that computer-based trading may lead to episodes of illiquidity and instability, including 'Flash Crashes'. 

The study also presents a cost and benefit analysis of each of the tools available to policy makers to curb high-frequency trading (HFT).