Electronic copy available at: http://ssrn.com/abstract=2235963
Moore’s Law vs. Murphy’s Law:
Algorithmic Trading and Its Discontents
Andrei A. Kirilenko
and Andrew W. Lo
This Draft: March 19, 2013
Financial markets have undergone a remarkable transformation over the past two decades due toadvances in technology. These advances include faster and cheaper computers, greater connectivity among market participants, and perhaps most important of all, more sophisticatedtrading algorithms. The benefits of such financial technology are evident: lower transactionscosts, faster executions, and greater volume of trades. However, like any technology, tradingtechnology has unintended consequences. In this paper, we review key innovations in tradingtechnology starting with portfolio optimization in the 1950s and ending with high-frequencytrading in the late 2000s, as well as opportunities, challenges, and economic incentives thataccompanied these developments. We also discuss potential threats to financial stability createdor facilitated by algorithmic trading and propose “Financial Regulation 2.0,” a set of design principles for bringing the current financial regulatory framework into the Digital Age.
* Research support from the MIT Laboratory for Financial Engineering is gratefully acknowledged. Wethank David Autor, Matthew Baron, Jayna Cummings, Chiang-Tai Hsieh, Ulrike Malmendier, Mehrdad Samadi, andTimothy Taylor for helpful comments and suggestions. The views and opinions expressed in this article are those of the authors only, and do not necessarily represent the views and opinions of any institution or agency, any of their affiliates or employees, or any of the individuals acknowledged above.
MIT Sloan School of Management, 100 Main Street, E62–642, Cambridge, MA 02142, USA.
MIT Sloan School of Management, Laboratory for Financial Engineering, and CSAIL, 100 Main Street,E62–618, Cambridge, MA 02142, USA; and AlphaSimplex Group, LLC.