Streetwise Professor

August 12, 2011

Is It Just Me That Finds It Weird That Firms in the Business of Discovering Prices Don’t Use Prices?

Filed under: Derivatives,Economics,Exchanges,Financial Crisis II,Regulation — The Professor @ 8:06 pm

Exchanges are in the business of facilitating the discovery of prices.  The whole rationale for exchanges is that discovering more accurate prices encourages the efficient allocation of scarce resources.  That’s the value that they produce for society.

Which is why it peculiar, to say the least, that exchanges consistently don’t use prices to allocate a scarce resource at the heart of their businesses: communications capacity.  The recent volume surge caused by the intense volatility over the past week has taxed this capacity heavily, as this FT article shows.  Four major exchanges faced technical problems due to an avalanche of message traffic, most notably Borsa Milano.

To the extent that exchanges react to message traffic surges, they do so through non-price allocation methods, such as “throttling.”

As I have been discussing since the very first SWP post, exchange bandwidth is a scarce resource.  There can be intense spikes in bandwidth usage.  Some market participants exploit the fact that this capacity is not priced to engage in trading strategies that may be parasitical, predatory, and destablizing.  Even non-opportunistic use of exchange bandwidth can cause serious technical problems, including problems so severe that exchanges must shut down.   There is every indication that there are periodic tragedies of the commons on exchanges.

Pricing capacity, including peak-load pricing, is the obvious way to eliminate tragedies of the commons and abusive uses of system capacity.  You’d think that idea would come naturally to those in the business of pricing everything from stocks to bonds to soybeans.  But despite recurrent, and arguably increasingly serious, problems, exchanges uniformly shrink from this solution.

It was a puzzle to me five plus years ago.  It puzzles me still.

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5 Comments »

  1. Is it just me or are Western media outlets totally ignoring the charges against Yulia Timoshenko, or at best, spinning them hard? I mean, the Russian media reports that Ukrainian prosecutors say they’ve got evidence she was involved in a murder ten years ago, from the Americans no less, and we just let that one pass without a peep.

    Or is it just that Washington doesn’t like to see our ‘friends’ locked up, even ‘friends’ who’ve been tossed aside in the bazaar between the U.S. and Russia (what did Moscow get after all for backing that Libya resolution?)

    And is Timoshenko terrified of the Kremlins, the Ukrainians, or her old paymaster George Soros’ minions?

    Comment by Mr. X — August 13, 2011 @ 9:11 pm

  2. Western media is probably busy looking for more information about that Russian state PR campaign to promote Russian roads. That is killing funny.

    Comment by Ivan — August 14, 2011 @ 1:35 am

  3. This sounds a bit like FTR markets. May be they should borrow a thing or two from the power markets 🙂

    Comment by Surya — August 14, 2011 @ 12:38 pm

  4. “Western media is probably busy looking for more information about that Russian state PR campaign to promote Russian roads. That is killing funny.”

    The last half of the global recession was insufficiently deep and prolonged to collapse the Russian economy and impoverish the Russians sufficiently to get them to overthrow Putin and all his works, so that a desperate successor government will sell their energy assets to Western investors.

    We still have some hope for the upcoming depression will be sufficiently deep and prolonged that these assets will return to their rightful owners.

    Comment by a — August 14, 2011 @ 3:27 pm

  5. Not at all: the lack of a $2M PR campaign was the only thing stopping Russians from using those wonderful Russian roads. Once they do that, Russia will not be susceptible to any recessions any longer.

    Comment by Ivan — August 14, 2011 @ 11:59 pm

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