## Speed Limits for Financial Markets? Not So Fast

_IMF Blog, June 1, 2017_

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## Bibliographic details
- Authors: The Editors
- Published: June 1, 2017

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### Overview
- Event focus: On the afternoon of May 6, 2010, the "flash crash" produced a 998-point plunge in the Dow Jones Industrial Average that erased $1 trillion in market value in 36 minutes.  
- Research question: Do advances in information and communication technology amplify or dampen market volatility?
- Study and authors: Barry Eichengreen, Arnaud Mehl, and Romain Lafarguette present evidence in an IMF working paper titled “Thick vs. Thin-Skinned: Technology, News and Financial Market Reaction.”

### Competing hypotheses
- Thin-skinned hypothesis:
  - Advances in information technology cause prices to react more violently to news by enabling strategies associated with volatility, such as algorithmic trading and stop-loss orders.
  - High-frequency traders (popularized by Michael Lewis’s 2014 book, Flash Boys) are implicated in amplifying volatility.
- Thick-skinned hypothesis:
  - Advances in technology suppress volatility because faster information reduces the information disadvantages of uninformed investors.
  - When information asymmetries fall, uninformed investors are less likely to engage in trend following or herd behavior.

### Methodology (ingenious test)
- Laboratory: The foreign exchange market, with average daily volumes exceeding $4 trillion (more than the combined GDP of Italy and Brazil).
- Data and scope:
  - 240,430 observations for 56 bilateral exchange rates against the dollar.
  - Sample period: between January 1, 1997, and November 30, 2015.
- Identification strategy:
  - Markets divided into two groups: those with direct fiber-optic connections to major financial centers (Tokyo, London, New York) that receive news faster, and those without direct connections that receive news more slowly.
  - Measured currency reactions to major US economic news such as changes in gross domestic product, consumer prices, and monetary policy.

### Key findings and statistics
- Currencies traded in places with direct fiber-optic connections react less to major US economic news than currencies in places that receive news more slowly.
- The reaction in markets with direct connections is 50 percent to 80 percent smaller.
- Interpretation offered by the authors: faster transmission of market-moving news reduces volatility by leveling the informational playing field and reducing trend-following behavior among less informed investors.

### Implications and policy considerations
- The study’s evidence supports the thick-skinned hypothesis: broader and faster transmission of information can reduce market volatility.
- The authors decline to take a position on policy proposals that would slow the velocity of data flows (for example, electronic “speed bumps” intended to damp asset-price volatility).
- Policy takeaway: measures that increase information access and reduce informational asymmetries may help suppress volatility; slowing information flows is not clearly justified by these findings.

*Source: Speed Limits for Financial Markets? Not So Fast — The Editors, June 1, 2017 (IMF).*

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## References

- [https://www.imf.org/wp-content/uploads/2017/06/BLOG-1099x500-USA-NYSC-Traders-on-the-Floor_Andrew-Kelly_Reuters-Newscom.rtrleight594906.jpg](https://www.imf.org/wp-content/uploads/2017/06/BLOG-1099x500-USA-NYSC-Traders-on-the-Floor_Andrew-Kelly_Reuters-Newscom.rtrleight594906.jpg)
- [Thick vs. Thin-Skinned: Technology, News and Financial Market Reaction.](http://www.imf.org/en/Publications/WP/Issues/2017/04/07/Thick-vs-44810)

_Source: https://www.imf.org/en/blogs/articles/2017/06/01/speed-limits-for-financial-markets-not-so-fast_