README.md

MARKET-MAKING-RL

Creating a market-making RL agent in the high-frequency trading (HFT) setting for Stanford's CS234 final project. Our full paper is found here. As opposed to past RL attempts on the problem of market-making in the HFT setting, we physically implement the limit order book (LOB) when simulating our algorithm, which means that the market dynamics are explieiclty dependent on the (sum) of the market-makers actions.

Background

Market-makers provide the liquidity of the stock market, allowing people to buy and sell stocks. Liquidity is provided as "limit orders" in the form of asks that allow the market to buy stocks and bids that allow the market to sell stocks. A limit order has both a price and a number of stocks, and a limit order book (LOB) contains all bids and asks provided by a market maker. As a market-maker is only one provider of liquidity among many for stock, the midprice of a stock is decoupled from any one market and evolves over time according to a stochastic Brownian motion as the random variable $S_t$. The bids and asks are centered around the midprice with a difference of $\delta_b$, $\delta_a$ respectively, and a total spread of $\delta_b+\delta_a$:

The market only interacts with the bids and asks closest to the midprice, buying the cheapest ask and selling the highest bid. Modeling the rate of market orders is an active research field but generally follows a Poisson process with a rate $\lambda(q,\delta)$ where $q$ is the quantity of the best bid/ask and $\delta$ is the spread of the best bid/ask from the midprice. We begin with a base high-frequency trading market rates that are only a function of $\delta$ derived in 2006 by Avellaneda & Stoikov, then switched to a function of only $q$ derived in 2009 by Mykland & Zhang, and finally found a function of both derived in 2017 by Toke & Yoshida. We synthesize these functions to find the most robust and realistic model,

$$\lambda(s,\delta) = \exp\left( \vec{\beta} \cdot \left[\ln(1 + q),\ (\ln(1 + q))^2,\ \ln(1 + \delta),\ (\ln(1 + \delta))^2,\ \ln(1+\delta+q) \right] \right),$$

where $\vec{\beta}$ contains the 6 parameters $\beta_i$ which we fit by fitting a stochastic linear regression on a day's worth of S&P500 data. We verify that the shape of the parameters match our expectation by plotting the derived lambda equation (as a function of $s$, $\delta$ separately) on Desmos.

RL Model

We simulate market trajectories over uniformly spaced time intervals of $dt$. In reality, the arrival of discrete market orders itself follows a Poisson process with $\lambda=\bar{dt}$, but this doesn't matter for the high-frequency limit where we assume market order rates aren't coupled in time (besides inherent coupling via the time-evolution of the LOB). We find that $\bar{dt}\approx$ 1 millisecond. We simulate market trajectories of up to 10,000 timesteps, corresponding to a total simulation time of 10 seconds.

At each timestep, we first observe the state of the market, then place an action by submitting limit orders, and finally evolve the market one step and observe how the market has changed the LOB. We update our internal wealth $W$ and inventory $I$ by the market orders placed on the LOB, and keep track of our utility / reward function for each timestep.

Our observation at time $t$ is $$O_t = (S,W,I,q^b,\delta^b,q^a,\delta^a)_t,$$ where $S$ is the midprice, $W$ is the total wealth of the market maker, $I$ is the total inventory of the market maker, $q$ is the quantity of stocks in the best bid/ask, and $p$ is the spread of the best bid/ask from the midprice.

We take actions of the form $$A_t = (q^b, \delta^b, q^a, \delta^a)_t$$ which covers placing any number and price of bids and asks. We allow all of these numbers to be continuous and truncate them as necessary to ensure $q$ is an integer and bids are placed at values of cents. We allow the palcement of a negative number of bids and asks to remove existing bids and asks from the LOB, effectively widening the spread.

Reward Functions

Our goal is to optimize the final value of the agent at the terminal time. Assuming the agent is free to liquidate all of its stocks at the current midprice (using another market), its final value is $$V_T = W_T+I_TS_T.$$ To incentivize this behavior, we consider both an intermediate reward at each timestep and a final reward once the market has reached a terminal time, which parallels the rewards seen in prevous similar implementations (the CARA final utility from Lim & Grose, 2018 and the various reward schema used in Guo, Lin, and Huang (2023)). We use an intermediate reward of $$R_t = a\cdot dW_t + e^{-b(T-t)}\text{sgn}\left(dI_t\right) + c\cdot t,$$ where we tune $a,b,c$ to approximately weight each of these components equivalently.

We use a final reward of the CARA utility function used by Lim & Grose (2018): $$R_T = \alpha - e^{-r V_T}.$$

Policy

We use the proximal policy optimization (PPO) algorithm which uses a stochastic policy. While in a the real-world market actions are deterministic, we can always back out a deterministic policy later by taking the means of the learned stochastic policy.

Organization

main.py is run with arguments to train a MarketMaker within the directory setup, storing results in results/. The path of the code is as follows:

1. a Config is created from the arguments to store all hyperparameters and flags as well as organize the files in results/
2. a MarketMaker is created from the Config
3. MarketMaker creates a Policy and Market, loading an existing BasePolicy and BaseNetwork state dict if necessary
4. Market creates an OrderBook upon which to simulate trajectories
5. The MarketMaker is then either trained or plotted, according to args.

Arguments to Control Behavior:

• --expand number of epochs to expand a finished run to
• --load filename or path to load previous model with
• --plot just plot a model
• --good-results plot all models located in the directory /good-results
• --plot-after, -pa number of epochs after which to plot a full batch Arguments to Control Hyperparameters:
• Training
  • -nt number of timesteps per trajectory
  • -nb number of trajectories to sample per epoch
  • -ne number of epochs to train policy on
  • -lr float learning rate to pass to Adam optimizer
  • --update-freq number of gradient steps to perform each epoch, default 5
  • --uniform use a uniform trajectory length where when the LOB dies, all observations are zero
• Policy: default is MC returns, PPO policy update, use advantages
  • --td use td-eligibility-trace returns instead of the usual monte-carlo discounted returns
  • --noppo, -np use REINFORCE istead of the default PPO
  • --noclip, -nc when using PPO, don't clip the policy ratio
  • --noadv, -na use the returns instead of advantages
• Reward: default is an immediate dW reward
  • --no-immediate, -ni dont add any intermediate rewards
  • --always-final, -af always add a final reward
  • --add-time, -at add a time reward
  • --add-inventory, -ai add an inventory reward
• Initial State
  • --book-size, -bs initial number of stocks in the order book, default 10000

config.py

Hyperparameters are passed around using a Config instance that is used to initialize MarketMaker, Policy, Market, and OrderBook instances.

• default hyperparameters are stored in the kwargs for Config.__init__()
• get_config(args) is used to initialize a Config from the arguments passed through to main.py
• as epochs are updated, Config.set_name() is used to rename all run files with the correct current epoch

TODO:

• implement more efficient gradients with sparse CSR or CSC arrays (MaskedMarketMaker) for faster running
• incorporate testing of more reward functions, such as the CARA final utility from Lim & Grose, 2018 and the various reward schema used in Guo, Lin, and Huang, 2023.
• parameter tune TD $\lambda$ eligibility traces
• implement dynamically taking in the $p$ past trajectories and using more layers to generate a more robust policy
• create full CUDA version that uses tensor operations whenever possible, so that larger batch numbers can be used for better, more robust policies
  • create full MPS version (M1), which should just be changing the .to(device) line
• actually find the correct parameters for the market transaction rate instead of just eyeballing from Desmos