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Understanding the detection of high frequency trading in the

Philippine setting: Analyzing the effect of price liquidity and price
volatility
John Paul S. Tanyag

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Understanding the Detection of High-Frequency Trading in the Philippine
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 Understanding the Detection of High-Frequency Trading in

the Philippine Setting: Analyzing the Effect of Price Liquidity

and Price Volatility

Thesis Presented to the

Financial Management Department

Ramon V. del Rosario – College of Business

De La Salle University- Manila

In partial fulfillment of the requirements for the degree of

Master of Science in Computational Finance

John Paul S. Tanyag

Adviser:

Atty. Michael G. Munsayac

February 2021

1
 ABSTRACT

Strong macroeconomic fundamentals, growing interest in investing, simultaneous

whole day trading with market peers, and the continuous advancements and upgrades of

trading systems – these are the indicators of how the Philippine stock market had expanded.

With the technology playing a bigger role in such expansion, new forms of trading such as

high-frequency trading (HFT) are studied and analyzed by both regulators and investors. This

study examines the effects of price liquidity and price volatility based on the detected HFT

at the Philippine stock market. Using the thirty constituent companies at the Philippine Stock

Exchange Index (PSEI) on four different trading days, the researcher examined each whole

trading day for the detection of HFT and the computation of measures of price liquidity and

price volatility. The panel data analysis revealed a significant relationship between price

liquidity and HFT. The study recommends the development of HFT regulations in the

Philippines as HFT may have positive and negative effects concerning increase in liquidity

and risk for manipulative activity, respectively. Strengthening equal access to information

will ensure that everyone is either on an equal playing field or guided by regulation

accordingly.

2
 Table of Contents

ABSTRACT............................................................................................................................2
CHAPTER I: Introduction ......................................................................................................5
Background of the Study ....................................................................................................5
Statement of the Problem ....................................................................................................7
Objectives of the Study .......................................................................................................7
Hypothesis...........................................................................................................................8
Scope and Limitations of the Study ....................................................................................8
Significance of the Study ....................................................................................................9
Definition of Terms...........................................................................................................10
CHAPTER II: Review of Related Literature ........................................................................12
High Frequency Trading ...................................................................................................12
Algorithmic Trading .........................................................................................................15
Liquidity............................................................................................................................16
Volatility ...........................................................................................................................17
Philippine Stock Market ...................................................................................................19
HFT, Volatility and Liquidity ...........................................................................................20
Research Gap ....................................................................................................................23
Literature Map ..................................................................................................................24
CHAPTER III: Theoretical and Conceptual Framework......................................................25
Theoretical Framework .....................................................................................................25
Conceptual Framework .....................................................................................................26
CHAPTER IV: Methodology ...............................................................................................27
Research Design................................................................................................................27
Sampling Design ...............................................................................................................27
Data Description and Collection Method .........................................................................28
Variables ...........................................................................................................................31

3
 Model Specification and Method of Data Analysis ..........................................................33
CHAPTER V: Results and Discussion .................................................................................35
Normal, Cancelled and Modified Orders ..........................................................................35
HFT Statistics....................................................................................................................35
HFT Combinations............................................................................................................44
Volatility ...........................................................................................................................48
Liquidity............................................................................................................................51
Panel Data Regression Results..........................................................................................54
Summary of Findings ........................................................................................................56
CHAPTER VI: Conclusions and Recommendations ............................................................58
Conclusion ........................................................................................................................58
Recommendation ..............................................................................................................59
REFERENCES .....................................................................................................................61
APPENDIX ...........................................................................................................................67
Appendix 1. Descriptive Statistics of Variables ...............................................................67
Appendix 2. Exploring Panel Data ...................................................................................69
Appendix 3. Panel Data Regression Results .....................................................................79
Appendix 4. HFT Orders ..................................................................................................85
Appendix 5. Computed Liquidity and Volatility Measures ............................................216
Appendix 6. PSE Direct Market Access Rules ...............................................................219

4
 CHAPTER I: Introduction

Background of the Study

Based on the stock market profile released by the Philippine Stock Exchange

(“PSE”), the number of stock market investors breached more than 1.2 million as of end-

2019. The growing interest in the stock market and the advent of online trading are the

catalysts for the rapid growth of the investors in the PSE for the last five years (The Philippine

Stock Exchange, Inc., 2019).

Its main barometer, the PSE Index (“PSEi”) had grown over time due to an increase

in stock prices and had observed an expansion of market liquidity. From less than 5,000

trades per day during the late 1990s and early 2000s, the Philippine stock market had grown

to 30,000 trades per day as of 2013 (Crisostomo, Padilla, & Visda, 2013). These trades are

made by the mix of retail local investors who invest in stocks either for growth or speculation

and the institutional local and foreign investors who invest in stocks on growth, capital

preservation, or long-term investment. Several indicators had contributed to this expansion

such as an increase in interest to the PSE due to strong Philippine macroeconomic

fundamentals, the extension of trading hours from half-day trading since its inception to a

whole day trading in 2012, and the upgrade to a new trading system.

In 2012, the PSE introduced direct market access or DMA wherein clients can buy or

sell shares at the PSE for order queueing and order matching without any intervention on the

part of the broker. DMA intends to significantly increase the trading volume by faster

5
execution of trades. It is also helpful for the promotion of online trading giving investors

more options on how they will invest. The types of DMA include automatic order routing

(AOR) which permits clients of trading participants to send orders electronically using its

infrastructure and sponsored access which permits clients to submit orders directly to the

trading system of the PSE (Dumlao, 2012).

By November 2017, the PSE announced a replacement project of its trading system.

This system can handle the demands of high-frequency trading (HFT), a kind of trading

known for high speeds, turnover rates, and multiple orders within seconds. This trading takes

advantage of the fact that computers execute orders and handle faster information than human

traders. It has the potential to create short-term effects on the market (Cuajunco, Chua, &

Ngo, 2017).

According to Sy (2014), HFT is not widespread in the Philippines since there is no

regulation and considered to be not legal at this point. (Corpecon Research, 2017) added that

the PSE is just a small exchange compared to other exchanges such as Japan having HFT as

70% of the total trades. If HFT will be more prevalent in the Philippines, it will result in

having computers be replacing traders, and people specializing in financial engineering will

be the top professionals for the brokerage firms (Corpecon Research, 2017).

The increase in interest at the PSE and the introduction of breakthroughs such as the

DMA and the migration to the new trading system are the reasons why HFT activity is

prevalent in the Philippine stock market. It cannot be denied that the Philippine stock market

is attractive to investors, particularly the institutional and foreign ones.

6
 This study examined HFT through understanding the two measures of market quality

(Kelejian & Mukerji, 2015), price volatility and price liquidity.

Statement of the Problem

Global stock markets undertake developments meant to support the trading strategy

of every investor. The emergence of these developments caters to the growing technology of

which the investors having more options on how to place their cash. HFT caters to this

technology of better speed for faster execution of orders and a more complex way of having

a suitable trading strategy.

With the HFT taking place, there is a need to determine if it create a positive or

negative effect on the market or if these attract investor confidence and ensure investor

protection. The study aimed to examine the effect of price liquidity and price volatility on

HFT at the Philippine stock market.

Objectives of the Study

1. To apply methodologies on detection of HFT using the companies listed at the

Philippine Stock Exchange.

2. To compute for the volatility and liquidity measures of various PSE-listed companies.

3. To identify companies that have high and low liquidity and volatility based on the

specific trading days used in the study.

7
 4. To determine the best-fitted model which describes the relationship of volatility and

liquidity to HFT.

Hypothesis

1. H0: There is no relationship between the price liquidity and HFT.

Ha: There is a positive/negative relationship between the price liquidity and HFT.

2. H0: There is no relationship between the price liquidity and HFT.

Ha: There is a positive/negative relationship between price volatility and HFT.

Scope and Limitations of the Study

This study aimed to determine the effect of price liquidity and price volatility in the

detected HFT at the Philippine stock market. To detect HFT, the researcher adopted the

methodologies introduced from the studies of Cuajunco, Chua, & Ngo (2017), Ekinci (2017),

and Bjorkman and Darling (2018). The study was limited to this methodology and did not

consider other HFT detection methods. Other computations for volatility and liquidity were

also not considered aside from the mentioned in this study.

In terms of the data, the researcher collected the order type, order volume, order

flagging whether buy or sell, ask price, bid price and the stock price of the thirty listed

companies considering four different full trading days for 2019. The choice of year is two

years after the conduct of the adopted methodologies and the DMA implementation. The

identity of the brokers and the clients of the transactions were not presented due to the non-

disclosure policy and data privacy of the PSE.

8
Significance of the Study

Stock Market Investors and Traders

The study is helpful for the investors to discover a different strategy that they may

use in their trading securities. They will be guided on this trading strategy and knowing the

pros and cons of HFT and if implemented, they will be warier on their risk appetites and

investment objectives. On the part of the traders, they will be considering HFT as a concept

that is acceptable yet must be always be taken with extra caution, especially in price volatility

and liquidity checking.

Students and Future Researchers

The study will help students, researchers, and professionals particularly in the field

of Finance to be familiar with such phenomenon happening in the Philippine stock market

setting. This is a very technical and diverse subject given the scarcity of resources for this

kind of discussion which will complement their understanding of the topic. It will also help

for a new perspective for the overview seen at the stock market.

Regulators and Self-Regulatory Organizations

Effective regulation is necessary on HFT for it to be not abused and cause possible

market manipulation. The study will be a tool for the government and corporate regulators

involved, the Philippine Securities and Exchange Commission (“SEC”), the PSE, and the

regulation subsidiary Capital Markets Integrity Corporation (“CMIC”) to promulgate HFT

rules and ensure that it will not be used for any form of fraudulent activity. With this, the

investors will be confident to transact given the fairness and transparency.

9
Definition of Terms

1. Ask Price – the lowest acceptable price that a possible seller is willing to accept in

exchange for security (InvestingAnswers, 2020)

2. Bid Price – the highest acceptable price that a possible buyer is willing to pay for

specific security (InvestingAnswers, 2020)

3. Cancelled Order – change in the previously submitted normal order with the intent to

remove the placed order from the order entry system (Investopedia, 2019)

4. Day Order – the type of order valid until the end of trading day only (PSE Academy,

2011)

5. Limit Order – orders entered with a specified price and volume (PSE Academy, 2011)

6. Liquidity – the extent by which stock can be bought or sold in the market quickly

without negatively impacting stock value, the measure of how many buyers and sellers

are present, and whether transactions can take place easily (IG, 2019)

7. High-Frequency Trading – is a type of algorithmic trading characterized by high-speed

trade execution, extremely large number of transactions with a very short-term

investment horizon (Corporate Finance Institute, 2015)

8. Modified Order – change in the normal order due to desire to increase/decrease in order

volume, order price, and change in order validity and client account code (PSE

Academy, 2011)

9. Normal Order – placing of order whether buy order or sell order (PSE Academy, 2011)

10
10. Price Discovery – the process of which buyers and sellers interact to determine the

asset’s fair market price (The Free Dictionary, 2012)

11. Spread – the gap difference between an actual bid and ask price at any specific time

(Investopedia, 2019)

12. Volatility – the rate at which price increase or decrease given the set of returns. It is

indicative of the pricing behavior of the security and helps estimate fluctuations that

may happen in a short period. (The Economic Times, n.d.)

11
 CHAPTER II: Review of Related Literature

High-Frequency Trading

High-frequency trading, commonly known as HFT, is a kind of trading that uses

algorithms for making decisions, generation of orders, or execution of trades with the absence

of any intervention (Lange, 2017). Such algorithms shall be tested meticulously and

appropriately before being used, deployed, and adopted into the financial markets (Kauffman

& Dan Ma, 2015).

The main role of HFT is to automate the existing trading process without the need to

monitor the day-to-day transactions at the market. Through its high reliance on speed, it is

an upgrade from the normal mechanism taking advantage of necessary facilities and systems

to have faster information to execute orders than the traditional ones (Cuajunco, Chua, &

Ngo, 2017).

There is no global standard and uniform distinction on the behavior of HFT. Five

characteristics that can be attributed to HFT (US Securities and Exchange Commission,

2014): the use of high speed and sophisticated programs for generation and execution of

orders, use of co-location data feeds offered by various exchanges and financial

intermediaries to minimize latencies, shorter time frames, easy submission of cancelled

orders and ending the trading day flat.

Among the HFT strategies, there are commonly used strategies that depict that not all

HFT traders behave in the same way. The arbitrage strategy is used to detect and make a

12
profit from price discrepancies. The structural strategy attempts to take benefit of

susceptibilities in the market. The passive market strategy takes advantage of the movement

of the bid-ask spread to obtain profit. In the discretional strategy, traders detect and exploit

order flows to make profits. Layering, an identified market manipulative strategy, means

someone puts large sell or buy orders on a certain financial instrument which affects the price

of this instrument. Another manipulative strategy, spoofing means a trader puts a large sell

order to make it appear that there is a large selling interest and to find a corresponding buyer

(Bjorkman & Durling, 2018).

In the 1990s, investors can purchase and sell securities through electronic

communication networks. These types of networks are doing more buying and selling than

the usual exchange and are allowed to trade on other exchanges at any point, disregarding

the usual trading hours of the exchange (Kauffman & Dan Ma, 2015). Such networks

followed the trend of HFT, making exchanges and market data providers implement

innovative ideas that resemble necessary developments and provide an upgrade to the current

market infrastructure (Hendershott, Jones, & Menkveld, 2011).

According to Zhang & Powell (2011), HFT has a great influence on the confidence

of the investors in the market. With these technologies present, the HFT traders are given a

distinct and competitive advantage over regular traders, hence making leeway to investors to

be hindered with incentives and opportunities to try other investing methodologies.

13
 From the perspective of the regulators, the monitoring of financial transactions

involving HFT takes time due to the limited paper trail different from low-frequency trading

and regular trading and the high-frequency data which is voluminous and causes certain

issues and concerns on its transparency. In the Flash Crash Incident of 2010, the US

Securities and Exchange Commission allotted a lot of time determining the cause of the

drastic movement of the price caused by HFT, which had led to the decline in the confidence

of the investors in the market (Zhang & Powell, 2011). In terms of the countries imposing

the HFT regulation, the European countries tend to be the strictest, the Asia-Pacific countries

tend to be the relaxed ones, and the US and Canada tend to be in between.

According to Kauffman & Dan Ma (2015), the HFT activities in the Asia-Pacific

region constitute twelve percent of the total value. Being very diverse compared to the other

financial markets, the Asia-Pacific region had market structure leeway, unstable political

happenings, regulatory developments, competing for IT capabilities due to lack of

advancements, and the differing implementation of policies of every exchange.

In Japan, forty-five percent of the equities trading volume are HFT transactions of

which the order response time decreased due to the implementation of the “stability over

speed” concept. This concept enables the participants of HFT to explore the inefficiencies in

the share price across its domestic exchanges.

In Australia, regulators are having difficulty obtaining the full extent of HFT due to

the existence of alternating trading venues such as dark pools which makes the acquiring of

public information necessary for measuring trading activities impossible. HFT traders in

14
Australia deal in Chi-X Australia and Australia Securities Exchange, of which HFT accounts

for twenty-seven percent of the trading volume as of 2012. It seems to be a favorable venue

due to low latency in network communication and low transaction costs. Competition is also

prevalent in these trading venues forcing them to do necessary upgrades and innovations,

making it more interesting and accommodating to HFT takers.

In Singapore, the Singapore Exchange had technology developments and co-location

services which is supportive of faster trading cutting latency of the reaction times. Singapore

also included the implementation of circuit breakers to halt the trading of equity when it

experienced high price intraday volatility and other kinds of risk controls.

These countries impose regulations to ensure that the HFT will be in a friendly and

accommodating environment between the stakeholders and the participants. Japan had

removed the “five percent rule” with an absence of its upper limit, Australia imposed a

balanced HFT approach by having an update of its HFT rules from time to time and

Singapore make rewards on the transfer of the ownership fees through rebates (Kauffman &

Dan Ma, 2015).

Algorithmic Trading

Algorithmic trading, the broader group of HFT, refers to the trading that follows

instructions from machines or dedicated program tools based on stock price, trading volume,

and order time. It is used to minimize the amount of risk, cost and obtain desirable gains

15
(Cuajunco, Chua, & Ngo, 2017). Generally, orders placed through algorithmic trading are

matched at a higher amount of speed different from an ordinary placed order with human

intervention (Lange, 2017).

Algorithmic trading provides its investors’ benefits which include lesser transaction

costs, higher accuracy, and speed on transactions, anonymity, and confidentiality,

transparency, and access to different kinds of markets (Najjar, 2018). The earned

commissions are lower than the traditional ones because there is no personal intervention to

be compensated for their services. Its orders are entered anonymously and traded

automatically, with investors being provided with all the required information and how the

algorithm works in the market.

Liquidity

Liquidity can be determined if a market can trade a certain quantity at the soonest

possible time given the determined price. Being an elusive concept, the market observing

liquidity shall be near the prices that follow the transaction (Alt-Sahalia & Yu, 2009) which

affects asset returns and trading costs (Pereira & Zhang, 2010).

According to El-Wassal (2013), there are five dimensions to determine liquidity:

tightness or the low transaction costs, breadth or having orders with large value and minimal

impact, depth or having above prices and below prices given the abundant orders, immediacy

16
or having the orders placed and executed which affects trading efficiency, and resiliency or

the necessary speed that happen due to price fluctuations resulting from trades.

The trading speed may have an impact on liquidity either by removing the adverse

selection and inventory management which will tend to increase the supply of liquidity.

Speed is dependent on the trading strategy being implemented by the traders (Brogaard,

Hagstromer, Norden, & Riordan, 2015).

There is a positive correlation between liquidity and the lower estimates of noise at

high-frequency trading (Alt-Sahalia & Yu, 2009). In terms of an optional speed upgrade,

liquidity is dependent on the traders having the marginal benefit of the upgrade due to the

advantage in latency comparing to regular traders (Brogaard, Hagstromer, Norden, &

Riordan, 2015). Shocks in liquidity had a positive association with returns with the

corresponding prediction of return continuity (Bali, Peng, Shen, & Tang, 2014).

Volatility

According to Doron Avramov (2006), a decrease in stock price creates non-informed

liquidity selling activity which leads to an increase in volatility. On the other hand, an

increase in stock price creates informed liquidity which leads to a decrease in volatility on

the succeeding trading day. The greater the volatility, the fewer investors will save which

will result in a depletion in the investment. Too much volatility results in an increase in the

cost of capital and will result in the hampering of economic growth (El-Wassal, 2013).

17
 Volatility and trade volume are related to one another as new information changes

investor expectations on the stock, causing them to either buy or sell (Atkins & Dyl, 1997).

It determines the exposure of the company to certain risk factors and at the same time,

discovering trading opportunities necessary for the trade-offs on the risks and returns (Alt-

Sahalia & Yu, 2009).

An increase in volatility due to liquidity will result in having more uninformed

investors trading at the market. Using the knowledge on the fundamentals of the company,

the investor tends to be informed which will cause to do something to the price stability of

the security and cause the necessary signal of the possessed information. Such an increase in

the informed investors will cause an increase in the price impact and a decrease in the price

deviation (Doron Avramov, 2006). Volatility increase after the price decrease can also be

observed due to leverage and expected returns relevant to the time aspect. Through the

volatility effect, changes due to leverage result in a negative return and an increase in

volatility. Anticipated volatility increases result in the growth of return on equity which

decreases the stock price (Doron Avramov, 2006).

18
Philippine Stock Market

The Philippine Stock Exchange (“PSE”) is the only stock exchange in the Philippines

and one of the oldest exchanges in Asia which started as Manila Stock Exchange (“MSE”)

in 1927. Another exchange, the Makati Stock Exchange (“MKSE”) was formed in 1963 to

cater to the emerging Makati Central Business District. Both MSE and MKSE trade the same

securities of the listed companies. It was on December 23, 1992 when the two exchanges

merged and unified as the PSE with headquarters from Tektite, Pasig City to Ayala, Makati

City to its present headquarters at PSE Tower, Bonifacio Global City, Taguig City.

Trading in the PSE is a continuous session from 9:30 AM to 3:30 PM daily with a

recess from 12:00 PM to 1:30 PM. By the pre-opening phase at 9:00 AM, clients can enter,

modify or cancel orders without the execution and matching of the orders. At 9:15 AM,

clients can still enter orders except for modification and cancellation as they will be rejected

by the trading system. The market opens at 9:30 AM and continuously trading until 12:00

PM wherein orders can be posted, modified, cancelled, and executed.

There is a market recess from 12:00 PM to 1:30 PM wherein clients can post orders

but no market activity. Clients can modify and cancel orders but on the queue. Market

resumes trading at 1:30 PM wherein orders can be placed, modified, cancelled, and executed.

By 3:15 PM or the pre-close phase, the client can place, modify or cancel orders without

matching in place. By 3:18 PM or the pre-close no-cancellation phase, only placing of orders

are allowed. The market computes for the closing price at 3:20 PM and no market activity

can occur at this phase. It also follows the run-off phase from 3:20 PM to 3:30 PM wherein

19
clients can place orders and execute trades at the computed closing price. The trading ends

at exactly 3:30 PM.

The main index of the PSE is the Philippine Stock Exchange Index (“PSEi”) which

is composed of thirty publicly listed companies. The PSEi measures the relative changes in

the free-floated market capitalization of the thirty largest and most active common stocks

listed at the PSE. The selection of the companies on the PSEi is based on a specific set of

public float, liquidity, and market capitalization criteria. Aside from the main index, there

are six sectoral indices which are the All Shares Index, the Financials Index, the Industrial

Index, the Holding Firms Index, the Services Index, the Mining and Oil Index, and the

Property Index. (The Philippine Stock Exchange, Inc., 2019)

As of 2019, there are a total of two hundred seventy-three (273) companies listed at

the PSE.

HFT, Volatility and Liquidity

Hruska & Linnertova (2016) focused on testing the relationship between market

liquidity of futures and HFT activity on European derivatives markets. The study focused on

22 most traded stocks on London Stock Exchange from September 2014 to March 2015 with

one-minute observations on the market orders, limit bid orders, limit ask orders, traded

volume, number of shares, the money value of the bid and ask limit orders, realized volatility,

bid-ask spread and high-frequency trading activity as variables. Three regression models

20
were used in the study: the first model with HFT activity as explaining variables, the second

model with volume, average size of trades, and market activity is included aside from HFT

activity and the third model including all the variables. The model results are mixed and are

influenced by volatility.

Using a dataset of orders and trades from the French stock market, Anagnostidis &

Fontaine (2020) investigated HFT algorithms that constitute a source of systematic liquidity

risk. The HFTs exhibit higher co-variation in the liquidity as compared to non-HFTs which

indicates that order size and market timing are important sources of liquidity co-movement.

The study consists of thirty-three (33) companies of which the orders and transactions are

available for two hundred fifty-three (253) trading days with conditions for classifying an

HFT trader such as the lesser proportion of canceled orders over normal orders with the

cancellation of one hundred thousand (100,000) orders during the year and cancellation of at

least 500,000 orders with a lifetime of fewer than 0.1 seconds. The liquidity offered by the

HFTs is significantly less diverse than that of traditional traders using cross-asset learning

hypotheses of which have implications for market regulations in Paris.

Bundesbank (2016) investigated the effect of increasing the speed of financial market

activities in the capital market which focused on the impact of HFT activity on price volatility

and liquidity in various market phases. It used data from Dax and Bund futures contracts at

the microsecond level. Results show that active HFT market players take up a greater share

of trade in periods of heightened volatility while passive HFT market players are reducing

the supply of liquidity. It also found out that HF traders increase efficiency as HFT causes

21
news to be priced into market prices very quickly despite the difficulty of measuring it in a

microsecond range. The study recommended that passive HF traders should be incentivized

to provide liquidity even in unusual circumstances.

Hruska (2016) focused on examining the impact of HFT on the liquidity of securities

traded in the German Stock Exchange. Its data consisted of securities with average traded

volume exceeding ten (10) million EUR and market capitalization greater than two (2)

million EUR with the analyzed period from April 15, 2015 to October 19, 2015, given one-

minute intervals, excluding opening and closing auction. With the rising activity of HF

traders, the spread is becoming narrower and thus markets of tested shares are becoming

more liquid, having a positive relationship.

Bjorkman & Durling (2018) studied HFT and how it affected the Swedish stock

market based on volatility and liquidity. It used a single-day reconstructed order book data

retrieved from FinBas which was timestamped in nanoseconds with an order message and

cancelled and or modified order within 100 milliseconds defined as an HFT order. The data

was dependent before and after the earnings announcement of four different trading days,

getting the difference between the real earnings day and the four trading days as benchmarks.

Standard deviation was used to compute for volatility while the quoted bid-ask spread was

used to compute for liquidity. First level OLS regression was made on each stock followed

by simultaneous equations systems. HFT harms volatility and positive effect on liquidity

which emphasized that the liquidity of the stock is independent of the price of the said stock.

22
Research Gap

The study conducted by Cuajunco, Chua, & Ngo (2017) focused more on the

detection of HFT on three random Philippine companies for a particular time frame on a

trading day. This study further expanded the study made by Cuajunco, Chua & Ngo (2017)

and detected HFT using all the companies in the PSEI using whole-day trading data for four

different trading days.

Previous studies had considered HFT as their independent variable to determine the

relationship to its volatility and liquidity, being the dependent variables. These studies

focused more on the American and European markets being more established and developed

in terms of technology and market products. This study had used HFT as the dependent

variable with volatility and liquidity as the independent variables. Also, the study addressed

the gap of limited studies of HFT on emerging markets as the study focused on Philippine-

listed companies.

23
Literature Map

Bundesbank
(2016)
Hruska
(2016)
Hruska & Linnertova
(2016)
Bjorkman & Durling
(2018)
Anagnostidis &
Fontaine
(2020)

Liquidity HFT Volatility

Alt-Sahalia & Yu Henderhott, Jones & Campbell, Grossman

(2009) Menkveld & Wang
Pereira & Zhang (2011) (1993)
(2010) Zhang & Powell Atkins & Dyl
El-Wassal (2011) (1997)
(2013) Kauffman & Dan Ma Alt-Sahalia & Yu
Bali, Peng, Shen & (2015) (2009)
Tang (2014) Cuajungco, Chua & Pereira & Zhang
Brogaard, Hagstromer, Ngo (2017) (2010)
Norden & Riordan Lange
(2015) (2017)
Naiijar
(2018)

Figure 1. Literature Map of HFT, Liquidity and Volatility

24
 CHAPTER III: Theoretical and Conceptual Framework

Theoretical Framework

According to Kyle (1985), the stock price volatility partially reflects informed trading

and is independent of liquidity-driven effects. Informed traders tend to trade aggressively if

such a higher level of noise trading volume exists due to the uninformed trading volume

being a cover-up to the normal order flow of the market.

There are two scenarios introduced from the model: the first scenario being the

informed trader revealing information, causing the depletion in the level of price uncertainty

which causes the negative correlation with the price volatility and the second scenario being

the informed trader trading aggressively, causing the price uncertainty and the positive

correlation with the price volatility.

The theory of trading volume introduced by Karpoff (1986) states that the trading

volume increases with the number of shares, decreases with the bid-ask spread, and positive

in non-event periods, given the assumption that the market agents frequently revise demand

prices and randomly encounter potential trading partners. The model also shows that the

existence of abnormal trading volume does not necessarily implicate disagreement on the

part of the investor, and such an increase in volume will happen given the available

information and diversified expectation.

Information and liquidity are the two important motives in trading (Admati &

Pfleiderer, 1988). Informed traders trade based on undisclosed information while liquidity

25
traders trade for reasons not directly to the future payoffs of financial assets. Admati &

Pfleiderer (1988) presented the theory of trading patterns which states that discretionary

liquidity trading is typically concentrated, informed traders trade more actively in these

observed concentrations and stock prices are more informative because of the concentrated

liquidity trading.

Conceptual Framework

Independent Variable Dependent Variable

Price
Liquidity
High Frequency Positive/Negative
Trading Effect
Price
Volatility

Figure 2. Conceptual Framework

26
 CHAPTER IV: Methodology

Research Design

This study utilized the quantitative research design to determine the impact of HFT

on the liquidity and volatility of the PSE-listed companies. Quantitative research design is

used to determine the relationship among variables through the collection and analysis of

given numerical data. It is used to find patterns, compute averages and forecasts, test

causality, and generalize results.

In this study, HFT was the dependent variable and the liquidity and volatility

measures were the independent variables. Statistical tools were used for the computation and

the testing of the relationship between the said variables.

Sampling Design

The sampling design was purposive sampling, with the Philippine Stock Exchange

Index (PSEI) as the basis of the companies to be included in the study and the four trading

end days per quarter as the period of the study due to data limitations.

All the thirty (30) constituent companies in the PSEI were included. The benchmark

of the stock market, the PSEI, is a ranking of the top 30 companies based on full market

capitalization (The Philippine Stock Exchange, Inc., 2011). Since constituent companies of

the PSEI are the most traded and most valued in the PSE, HFT was deemed more likely

present than those companies that are thinly traded and having minimal value (Hruska, 2016).

27
 The choice of four trading days with different periods was adopted from the study of

Bjorkman & Durling (2018) except the last trading day of the quarter.

Data Description and Collection Method

The listed companies (PSEI) used in the study were the following:

Table 1: Composition of PSEI

Company Name Stock Symbol

Ayala Corporation AC
Aboitiz Equity Ventures, Inc. AEV
Alliance Global Group, Inc. AGI
Ayala Land, Inc. ALI
Aboitiz Power Corporation AP
BDO Unibank, Inc. BDO
Bloomberry Resorts Corporation BLOOM
Bank of the Philippine Islands BPI
DMCI Holdings, Inc. DMC
First Gen Corporation FGEN
Globe Telecom, Inc. GLO
GT Capital Holdings, Inc. GTCAP
International Container Terminal Services, Inc. ICT
Jollibee Foods Corporation JFC
JG Summit Holdings, Inc. JGS
LT Group, Inc. LTG
Metropolitan Bank & Trust Company MBT
Megaworld Corporation MEG
Manila Electric Company MER
Metro Pacific Investments Corporation MPI
Puregold Price Club, Inc. PGOLD
Robinsons Land Corporation RLC
Robinsons Retail Holdings, Inc. RRHI

28
 Semirara Mining and Power Corporation SCC
Security Bank Corporation SECB
SM Investments Corporation SM
San Miguel Corporation SMC
SM Prime Holdings, Inc. SMPH
PLDT Inc. TEL
Universal Robina Corporation URC

The data were collected from two sources, Bloomberg and the PSE. The data were

extracted and consolidated, which included all the placed orders, cancelled orders, and

modified orders of every security per trading day which is timestamped to its nearest second.

Data were extracted from four different trading days with different periods, the last

trading day of the four quarters of the year. The date for complete one whole day was

extracted to capture the trading and price movement of each listed company on that

mentioned day.

Table 2: Sample Periods and Specific Dates

Period Date
First Day (D1) March 29, 2019
Second Day (D2) June 28, 2019
Third Day (D3) September 30, 2019
Fourth Day (D4) December 27, 2019

Based on the studies of Cuajunco, Chua, & Ngo (2017), Ekinci (2017), and Bjorkman

& Durling (2018), an HFT order is identified as an order message and a subsequent cancelled

or modified order message. Bjorkman & Durling (2018) defined the time difference of the

29
order messages to be not more than 100 nanoseconds. In the study of Cuajunco, Chua, &

Ngo (2017), the time difference of the order messages be not more than 10 seconds.

Since the sources of data (Bloomberg, PSE) had no facility to present HFT and given

that the Philippines is not yet formally introducing HFT as a regulated trading mechanism,

the quote stuffing HFT detection methodologies of Ekinci (2017) and Cuajunco, Chua, &

Ngo (2017) were applied. According to Nasdaq, quote stuffing is a trading practice of placing

an unusual number of buy or sell orders on a particular security and then immediately

cancelling them.

First, the orders were extracted from the system. The orders were arranged from the

first placement to the last placement, and tagged the orders that had the following behavior

as HFT order:

• order posting then modification

• order posting then cancellation

• order modification prior cancellation

• two successive modifications

After order tagging, the next step was the examination of the order time of the placed

HFT orders to determine whether the orders are placed in the fastest possible time from one

order to another. This step also determined whether an HFT order had an order time

difference of no more than two seconds.

30
 Modified
Order
Normal HFT
Order Order
Cancelled
Order

T+0 Not more

(time) than T+2
seconds

Figure 3. Determination of an HFT Order

Variables

For liquidity, the study used spread measures as proxies which were also used on the

studies of Hendershott, Jones, & Menkveld (2011) and Hruska (2016), these are the relative

spread and effective spread.

The relative spread (relspread) is the bid-ask spread divided by the market price.

𝑎𝑠𝑘 𝑝𝑟𝑖𝑐𝑒 − 𝑏𝑖𝑑 𝑝𝑟𝑖𝑐𝑒

𝑟𝑒𝑙𝑠𝑝𝑟𝑒𝑎𝑑 =
𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒

31
 The effective spread (espread) is the difference between the midpoint of the bid and

ask quote spread and the share price. For the tth trade in stock j, effective spread (espread) is

defined as:

𝑒𝑠𝑝𝑟𝑒𝑎𝑑 = 𝑞𝑗𝑡 (𝑝𝑗𝑡 − 𝑚𝑗𝑡 )/𝑚𝑗𝑡

where qit is the indicator of whether it is a buy (+1) trade or sell (-1) trade, mjt is the

midpoint price or price between the bid and ask price and pjt is the current price of stock j at

time t.

For volatility, the standard deviation was used as a proxy similar to the computations

used by Hruska (2016) and Bjorkman & Durling (2018) which has the formula:

𝑛
1
𝜎=√ ∑(𝑢𝑖 − 𝑢̅)2
𝑛−1
𝑖=1

∑𝑛
𝑖=1 𝑥𝑖
𝑢̅ =
𝑛

𝑃𝑖−1 − 𝑃𝑖
𝑢𝑖 =
𝑃𝑖

where 𝜎 is the standard deviation, 𝑢̅ is the price average of all data points at n

observations at time i and 𝑢𝑖 is the price return at time i.

The study used this formula for the computations of the daily price volatility (using

closing prices) using the variable volhist and HFT price volatility (using HFT order prices)

using the variable volwithin.

32
Model Specification and Method of Data Analysis

The model specification was designed to examine the effect of HFT on the liquidity

and volatility of the Philippine stock market. It follows the model suggested by Bjorkman &

Durling (2018) using panel data regression analysis. Applying our variables, the estimated

model is as follows:

HFTit = β0 + βi volhist it + βi volwithinit + βi relspreadit + βi espreadit + ϵit

Given the nature of the data and based on the review of literature, panel data

regression was used for the analysis. This gave the necessary explanation of the relationship

between the independent variable and the dependent variable.

There were three methods used for estimation of panel data models: the pooled OLS

regression which assumes that the regressors are exogenous, the fixed effects method which

is used to analyze the impact of the variables which vary over time and the random effects

method which assumes that the constants for each section to be random instead of fixed.

To determine the appropriate estimation method, the study used the F-test of joint

significance for the fixed effects model, the Breusch-Pagan Lagrange Multiplier (LM) for

random effects model. The joint significance F-test was used to determine the appropriate

method between Pooled OLS and fixed effects; a significant p-value rejects the null

33
hypothesis that the coefficients are jointly equal to the Breusch Pagan LM Test to determine

the appropriate method between Pooled OLS and random effects. A significant p-value

rejects the null hypothesis that the Pooled OLS regression is the appropriate model, allowing

us to choose the random effects model. To obtain heteroscedasticity and autocorrelation-

robust standard errors, the robust-regression option in STATA was used.

The standard Hausman test was used to determine the appropriate estimate method

between the fixed model and random model. A significant p-value implies that the fixed

effect model is preferred over the random effects model. The study also tested for

multicollinearity to determine if there were violations of the assumption that variables require

no exact linear relationship and heteroskedasticity for the fixed effects model using the

Modified Wald Test.

The study did not conduct the testing for serial correlation or the Lagram Multiplier

test since this is applicable only on macro panels having long time series with over 20 to 30

years as compared to our study having micro panel data with only four trading days.

34
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