VPIN (Volume synchronized Probability of Informed trading) is a leading
indicator of liquidity-induced volatility. It is best known for having
produced a signal more than hours before the Flash Crash of 2010. On
that day, the market saw the biggest one-day point decline in the Dow
Jones Industrial Average, which culminated to the market value of $1
trillion disappearing, but only to recover those losses twenty minutes
later.
The computation of VPIN requires the user to set up a handful of free
parameters. The values of these parameters significantly affect the
effectiveness of VPIN as measured by the false positive rate (FPR). An
earlier publication reported that a brute-force search of simple
parameter combinations yielded a number of parameter combinations with
FPR of 7%. This work is a systematic attempt to find an optimal
parameter set using an optimization package, NOMAD (Nonlinear
Optimization by Mesh Adaptive Direct Search). We have implemented a number of
techniques to reduce the computation time with NOMAD. Tests show that
we can reduce the FPR to only 2%.
To better understand the parameter choices, we have conducted a series
of sensitivity analysis via uncertainty quantification on the
parameter spaces using UQTK (Uncertainty Quantification
Toolkit). Results have shown dominance of 2 parameters in the
computation of FPR. Using the outputs from NOMAD optimization and
sensitivity analysis, We recommend A range of values for each of the
free parameters that perform well on a large set of futures trading
records.