Some stock market transactions require quick action to grab an opportunity before the competition, which affects risk management. Matthieu Bouvard, a finance researcher at McGill University, studied the impact of time pressure on stock trader transactions, with a particular focus on arbitrage.
High execution speeds can lead to an accumulation of risk that can cause problems within the financial institution.
In some cases, a company’s stocks may be traded on more than one market, for example, on the New York Stock Exchange and the Shanghai Stock Exchange. However, the stock price of a dual-listed company may differ temporarily on the two markets. Traders are then tempted to exploit the price discrepancy by buying undervalued shares on one exchange while selling the same number of higher-value shares on the other exchange.
According to the theoretical model built by Matthieu Bouvard, in this situation, if the trader expects caution on the part of the competition, he will allow himself more time to assess the transaction parameters. While this is preferable from a risk management perspective, it is not always the chosen option: if the trader expects everyone else to be hasty, he will act as quickly as possible, thereby increasing the risk.
This study recognized the impact of a trader’s expectations on the speed at which he will act, and therefore on his risk management choices. Taken collectively, high execution speeds can lead to an accumulation of risk that can cause problems within the financial institution, or even contribute to a financial crisis. The researcher has shared his findings with a number of finance stakeholders, including those responsible for regulating the financial sector, in order to explore options that could help reduce these risks.