Making Millions in Milliseconds at McIntire Hedge Fund Tournament

April 28, 2008 — In his book, "Information Markets," University of Virginia commerce professor Bill Wilhelm charts how investment banks over the past 20 years have gradually moved their New York City trading offices closer and closer to the New York Stock Exchange in lower Manhattan.

In this information age, stocks are traded primarily over computer networks linked to the hub at the New York Stock Exchange building, which seemingly would reduce the need for physical proximity. But the firms moved closer, sometimes by just a few blocks, in order to be able to execute trades just a few milliseconds faster, explained fellow commerce professor Stefano Grazioli.

That reality — that today's financial markets move so quickly that milliseconds matter — undergirds the creation of the McIntire Hedge Fund Tournament, where students combine computer programming and finance skills to build custom computerized trading systems that interact with a simulated stock market.

"When the market moves at these speeds, you can't afford not to have systems that are heavily automated," said Grazioli. "[The students] need to learn to put together the algorithm and the understanding of the problem that comes from finance, with the understanding of the technology and the speed that only a computerized system can give you."

The fifth annual tournament took place Friday morning in a state-of-the-art stock-trading room in the McIntire School of Commerce's new Robertson Hall, where large video screens charted the investment performance of the student teams. In Grazioli's simulated stock market, six months were squeezed into three hours, as a simulated day of stock market activity passed every 60 seconds, keeping the students hunched over their computer screens to monitor how well their custom-written software was performing.

The tournament is primarily a culminating project for Grazioli's "Financial Systems Engineering" class, but it is open to any student at U.Va., and each year there are a few "ghosts," as his students call those who participate without taking the class. Members of the top two teams took home engraved iPods provided by the tournament sponsor, Wachovia, which also paid for the computer server that ran the tournament.

The teams were each given a simulated $30 million in a combination of cash, options and stocks, which included Apple, IBM, Yahoo, GE, Capital One, Google and Goldman Sachs. The teams can't sell the securities, and must use the cash to purchase offsetting stock options that will effectively smooth out any jumpy stock price movements in order to generate a moderate, steady profit for the portfolio as a whole.

Grazioli explained what a hypothetical investor would want from his hedge fund managers: "If they make too little, they're not managing my money well. If they make too much, it means they took some bets, and I don't want them to do that. So still they're not managing my money well."

A team wins the tournament by minimizing their 'tracking error' – the difference, measured weekly (i.e. every seven minutes of tournament time), between the value of their portfolio and a portfolio value target that would reflect a 'risk-free' rate of return (2.5 percent).

Many of the 15 teams spent 40 hours or more preparing for the event, said Grazioli. "Virtually everybody that I ask tells me that this is the most complex problem that they have solved in their entire academic career. Not necessarily the hardest, but certainly the most complex — the most data, most moving parts, fastest moving, and so on."

Wachovia representative Meggie Powers agreed that the event posed quite a challenge. "This takes into account much more than anyone would be asked to do, especially in your first job out of college," said Powers.

The top four teams in this year's tournament all performed extremely well, and this year's winning team managed to keep its average rate of return within 0.5 percent of the target rate over the entire time of the simulation, said Grazioli, a significant improvement over last year's winning performance, which stayed within 3 percent of the target rate. "Every year the winners are a bit more sophisticated."

The overall winning team members were Scott Tucker, Michael Ledwith and Mark Paddrik, all three of whom are fourth-year systems engineering majors in the Masters Early Research Program of the School of Engineering and Applied Science.

To refine their software and strategies, they did repeated trials on eight sets of practice data, applying tweaks first on one set of data, and then checking if the tweaks also improved the results with the other seven sets of data.

When asked about the iPod prizes, Ledwith said, "Even better than an iPod is not having to write an extra paper."

The second-place team was comprised of fourth-years Adam Ahmed, a computer engineering major, Ye Liang, a computer science major, and Jonathan Lee, a finance major in the Commerce School.

All of the winning students came from Grazioli's class.

As a prelude to the tournament, Wachovia also sponsored a panel discussion on April 21 where builders and users of Wachovia's own custom stock-trading systems shared some real-world examples of how today's traders depend on technology, said Grazioli. They noted that when the currency exchange traders try to look at the real-time exchange rates, the numbers move so fast they can't be read, he said. So the traders must look at them as a trend line on a graph, and they must set up computerized trading rules that can react fast enough.

Whether or not the tournament participants go on to jobs that use these skills (like one student this year who has taken a related job with Wachovia), many of them enjoy the challenge of solving a real-world problem, explained Grazioli. "About 10 percent of them in the anonymous class comments tell me this is the best class they have taken."

— By Brevy Cannon