Latency, Liquidity and Price Discovery
Queen's School of Business
Karlsruhe Institute of Technology
November 22, 2011
Journal of Financial Markets, Forthcoming
The speed of trading is an important factor in modern security markets. We still know relatively little about the effect of speed on liquidity and price discovery, two important aspects of market quality. On April 23rd, 2007, Deutsche Boerse made the most important upgrade to their trading system since 2002. With the 8.0 release of Xetra, system latency was reduced from 50 ms to 10 ms. Both quoted and effective spreads decreases post upgrade. This increase in liquidity, is due to dramatically lower adverse selection costs that are only partially translated into higher liquidity. We interpret this as a decrease in the competition between liquidity suppliers who are able to increase their revenues by more than 185 million Euros. The contribution of quotes to price discovery doubles to 90% post upgrade, indicating that prices are more effcient.
Number of Pages in PDF File: 34
Keywords: Liquidity, Latency, Execution Speed, Exchange Systems, Price Discovery
JEL Classification: G14
Date posted: August 24, 2008 ; Last revised: April 13, 2012
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