Trading of Complex Commodities Josh Johnson

Trading Buyers Sellers

For Example Car Buyers Car Dealers

Another Example Car Buyers Car Dealers Manufacturers

Central Marketplace Marketplace

Central Marketplace Marketplace Necessary?

Central Marketplace Bulletin board Necessary?

Central Marketplace Bulletin board Middleman Necessary?

Central Marketplace Bulletin board Middleman Auction Necessary?

Central Marketplace Bulletin board Middleman Auction Exchange Necessary?

Examples of Exchanges Stock/Commodity exchanges Specialized exchanges (e.g. specialist systems)

Example of an Order Buy a red Mustang

Example of an Order Buy a red Mustang, less than 2 years old

Example of an Order Buy a red Mustang, less than 2 years old, willing to pay $25,000

Example of an Order Buy a red Mustang, less than 2 years old, willing to pay $25,000 OR Any color Corvette, brand-new, willing to pay $30,000

General Case An order describes a set of items, such as the Mustangs and Corvettes.

General Case An order describes a set of items, such as the Mustangs and Corvettes. The buyer wants to get one of these items.

Graphical View of an Order Space of all items

Graphical View of an Order Space of all items Red Mustangs less than 2 years old

Graphical View of an Order Space of all items Red Mustangs less than 2 years old All color Corvettes made this year

Price Space of all items $25,000 $30,000 Mustangs Corvettes Price is a function of an item. Price

Buy and Sell Orders Price Buy order

Buy and Sell Orders Price Buy order Price Sell order

Matching Two orders match if they intersect…

Matching Two orders match if they intersect… Price Buy order

Matching Two orders match if they intersect… Price Buy order Sell order

For Example Buy: Red Mustang, Made after 1998, For $25,000 or less OR Any color Corvette, Made in 2001, For $30,000 or less

For Example Buy: Red Mustang, Made after 1998, For $25,000 or less OR Any color Corvette, Made in 2001, For $30,000 or less Sell: 2001 black Mustang, For $24,000 or more OR 1996 red Mustang, For $18,000 or more OR 2001 silver Corvette, For $28,000 or more

For Example Buy: Red Mustang, Made after 1998, For $25,000 or less OR Any color Corvette, Made in 2001, For $30,000 or less Sell: 2001 black Mustang, For $24,000 or more OR 1996 red Mustang, For $18,000 or more OR 2001 silver Corvette, For $28,000 or more Intersect

For Example Buy: Red Mustang, Made after 1998, For $25,000 or less OR Any color Corvette, Made in 2001, For $30,000 or less Sell: 2001 black Mustang, For $24,000 or more OR 1996 red Mustang, For $18,000 or more OR 2001 silver Corvette, For $28,000 or more Fill: 2001 silver Corvette, For $29,000

Fill A result of trading, that is, an item that matches both orders.

Fill A result of trading, that is, an item that matches both orders. Price Buy order Sell order

Formal Definition An order is an item set I

Formal Definition An order is an item set I, and a function Price: I R +

Formal Definition An order is an item set I, and a function Price: I R + A fill is an item

Formal Definition An order is an item set I, and a function Price: I R + A fill is an item, and a price p, such that

Matcher Engine Limitations: Specific items in sell orders Restrictions on buy item sets No price functions

Specific Sell Orders Good: Sell a red Mustang made in 1999 Bad: Sell any color Mustang made before 1999

Restrictions on Buy Item Sets Year Color Good: Year Color Bad:

No Price Function Price Good: Price Bad:

Matcher Architecture Matcher

Matcher Architecture Matcher User interface User interface User interface Orders Fills

Matcher Architecture Matcher Index of sell orders List of buy orders User interface User interface User interface Orders Fills

Trading Cycle Process all incoming orders Re-match all pending orders Stop trading? Yes No

Matching Process For each buy order, search the indexing structure for matching sell orders When finding matches, generate fills

Fairness Prefer matches with better prices Give priority to better-price orders Give priority to earlier orders

Extensions Order modification Disjunctive orders Confirmations

Running Time Almost linear in the number of orders Almost linear in the length of order description Memory is the main bottleneck.

Performance 400 MHz PC with 384 Mbytes memory, C++ implementation under Windows NT: 100,000 pending orders 500 new orders per second

Extended Architecture Matcher Broker User Interface User Interface User Interface Broker Orders Fills Orders Fills Orders Fills Orders Fills Orders Fills

Extended Architecture Matcher Broker User Interface User Interface User Interface Broker Orders Fills Orders Fills Orders Fills Orders Fills Orders Fills Distributed Matcher

Broker Functions Pre-compile complex orders Handle price functions Handle complex item sets Shield the user from processing delays Support automated trading

Advantages Fewer limitations on orders Extra features Distributed computation

Coming Soon Broker algorithms Empirical performance study