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To: ms.smartest.person who wrote (941)	1/4/2002 3:34:18 AM
From: ms.smartest.person	Read Replies (1) \| Respond to of 5140

The Perfect Profit Spot Title:Forthcoming Location Matters: An Examination of Trading Profits Harald Hau Why do some financial traders outperform others in terms of profits? In the last 20 years, many indications point to the role of information asymmetries between agents, and court verdicts on insider trading point to information advantages (typically for corporate insiders). But perhaps they’re missing the mark. Recent research by Harald Hau, INSEAD Associate Professor of Finance, empirically investigates how information advantages are related to the geographic location of a trader, discovering the correlation of success or failure with where they are situated. Professor Hau proposes a series of questions with great practical interest: do traders located in foreign countries underperform relative to domestic traders when it comes to proprietary trading of domestic equities? If yes, are language barriers the key to performance differences? Do traders located close to the stock market (eg in Frankfurt) do better for DAX stocks than traders in regional centres (like Munich)? Do traders in Munich outperform traders in Frankfurt when it comes to trading stock that has its corporate headquarters in Munich? Do larger institutions with many traders outperform smaller institutions, owing to scale economics in the production of information? Previous research had inferred information advantages indirectly from portfolio bias, namely from the fact that traders favour domestic stocks with which they are presumably more familiar. But the ultimate test of superior information is superior trading performance. Thus, Professor Hau examined new microeconomic data on more than 1300 traders using the electronic Xetra trading system (Xetra does not discriminate institutionally, making its data ideal for tracing asymmetric information within the trader community). The research concentrates on the 756 traders who did at least 10 (own account) transactions in any of the 11 German blue-chip stocks over a four-month period. These large traders are widely distributed geographically, but nevertheless, all traders enjoyed the same fair access to the electronic trading platform. Because the research spans a short four-month period, the statistics measure risk-adjusted profits at different horizons to get accurate, meaningful results. It distinguishes between high-frequency trading (based on intra-day profits), medium-frequency profits (based on weekly profits) and low-frequency (based on monthly profits), then uses linear regression to explore the role of location for individual trading profits at each respective frequency. The findings: a trader’s location in Frankfurt does not provide a comparative profit advantage, suggesting a lack of information for ‘financial centre advantage’, and further implying that local trader interaction is not crucial for trading success. In contrast, however, a location in a foreign non-German speaking city produces a strongly negative correlation with profitability across all three frequencies. This underperformance of foreign-based traders is of considerable economic magnitude. For example, the relative quarterly profits loss of a foreign-based trader averaged DM 240,000 (approx. 123,000 Euros) per account with more than 10 proprietary transactions. However, traders in the other German-speaking countries (Austria and Switzerland) did not show significantly lower profits, suggesting that linguistic and cultural barriers, rather than geographic distance per se, are key factors of the information advantage identified in the data. The research also tested for local proximity advantage, marking all traders at a distance of less than 100 kilometres from one of the nine corporate headquarters outside Frankfurt to see whether their trading performance was superior. Professor Hau found that local headquarter proximity is positively correlated with intra-day profits, but this was not so at lower frequencies, indicating only a very short-lived local information advantage when a trader has local proximity to a corporate headquarter. The data also show no evidence that larger financial institutions have a better trading performance than smaller ones. ‘Information scale economics’, therefore, do not seem to exist in proprietary equity trading. The research confirms that geography is important in determining how information is distributed across market participants. In particular, the profit difference between domestic and foreign traders (ie those based in non- German speaking centres) appears to be very pronounced. These results suggest that market-making in equity might be less of a global business than often asserted. knowledge.insead.edu