Liquidity Measure Distortions in Fast Markets: Expensive and Cheap Solutions

48 Pages Posted: 10 Mar 2012

See all articles by Craig W. Holden

Craig W. Holden

Indiana University - Kelley School of Business - Department of Finance

Stacey E. Jacobsen

Southern Methodist University (SMU) - Finance Department

Date Written: March 9, 2012

Abstract

We investigate how the increase in speed of U.S. equity markets has distorted liquidity measures. We find that the widely-used Monthly Trade and Quote (MTAQ) database yields a percent effective spread 43% higher than our benchmark, a quoted spread that is nonpositive nine times more often, and a potential cost of poor routing decisions of $8.4 Billion/year. We test ways to eliminate or mitigate these distortions. We find that the best solution is to use the expensive Daily Trade and Quote database. If a researcher is financially constrained, then the second best solution is to use MTAQ with our new Interpolated Time technique and two other techniques.

Keywords: millisecond, high-frequency trading, low-latency trading, NBBO, DTAQ, MTAQ, TAQ

JEL Classification: C15, G12, G20

Suggested Citation

Holden, Craig W. and Jacobsen, Stacey E., Liquidity Measure Distortions in Fast Markets: Expensive and Cheap Solutions (March 9, 2012). Available at SSRN: https://ssrn.com/abstract=2019177 or http://dx.doi.org/10.2139/ssrn.2019177

Craig W. Holden (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

Kelley School of Business
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3383 (Phone)
812-855-5875 (Fax)

HOME PAGE: http://www.kelley.iu.edu/cholden

Stacey E. Jacobsen

Southern Methodist University (SMU) - Finance Department ( email )

United States

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