From Knowledge@Wharton, November 10:
There is no evidence yet of AI collusion hurting the financial markets, but the threat is real, warns a paper co-authored by Wharton’s Winston Wei Dou and Itay Goldstein.
As world leaders last week raised fears over runaway AI on the scale of a nuclear war or a pandemic, a more immediate and tangible frontier may well be the capital markets. The potential for AI technologies in capital markets to cause unintended effects arises when autonomous AI algorithms learn to act in concert automatically, either through a “price-trigger mechanism” that punishes deviations in trading behavior or through homogenized learning biases among algorithms, according to new research by experts at Wharton and elsewhere.
“Informed AI traders can collude and generate substantial profits by strategically manipulating low order flows, even without explicit coordination that violates antitrust regulations,” warned a research paper, titled “AI-Powered Trading, Algorithmic Collusion, and Price Efficiency,” by Wharton finance professors Winston Wei Dou and Itay Goldstein, and Yan Ji, professor of finance at the Hong Kong University of Science and Technology.
Quantitative hedge funds and leading investment firms like BlackRock and J.P. Morgan are already using AI, and that trend is gathering momentum across the financial markets. The SEC has recently given the green light to Nasdaq’s AI trading system, which utilizes reinforcement learning (RL) algorithms for making real-time adjustments. Wall Street has been clear so far of a scandal over AI-powered abuses, but the threat of that is palpable, according to Dou.
Red Flags on AI in Retailing, Manufacturing
Dou pointed to the Federal Trade Commission’s recent lawsuit accusing Amazon of using a secret algorithm to manipulate prices. “AI collusion in retail markets could drive prices to super-competitive levels as the algorithms learn to achieve and maintain coordination without any form of agreement, communication, or even intention,” he said. “Retailers and manufacturers have an incentive to gain market power without improving their product qualities. That’s why antitrust regulators are very nervous about this.”Dou said their paper addresses those very concerns. “We have seen the rise of adoption of AI trading in financial markets, so naturally we would ask similar questions — whether AI collusion will arise in the financial markets,” he said. “If that’s the case, the question is whether we will see important adverse real consequences. If there’s AI collusion in the financial markets, market liquidity and price informativeness may be hurt.” Put another way, he said the worry is whether the markets will effectively facilitate liquidity and if market prices will reflect “real fundamental information.”
Goldstein noted that the Amazon case apart, there is an increasing worry of AI collusion in several other markets....
....MUCH MORE
