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http://ssrn.com/abstract=1501135
 
 

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Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market


Alain Chaboud


Federal Reserve Board - Division of International Finance

Ben Chiquoine


Federal Reserve Board - Division of International Finance

Erik Hjalmarsson


Queen Mary - University of London, School of Economics and Finance; University of Gothenburg - Centre for Finance

Clara Vega


Board of Governors of the Federal Reserve System

July 5, 2013

Journal of Finance, Forthcoming
FRB International Finance Discussion Paper No. 980

Abstract:     
We study the impact of algorithmic trading in the foreign exchange market using a long time series of high-frequency data that specifically identifies computer-generated trading activity. Using both a reduced-form and a structural estimation, we find clear evidence that algorithmic trading causes an improvement in two measures of price efficiency in this market: the frequency of triangular arbitrage opportunities and the autocorrelation of high-frequency returns. Relating our results to the recent theoretical literature on the subject, we show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity, while the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence that algorithmic traders do not trade with each other as much as a random matching model would predict, which we view as consistent with their trading strategies being highly correlated. However, the analysis shows that this high degree of correlation does not appear to cause a degradation in market quality.

Number of Pages in PDF File: 42

Keywords: algorithmic trading, volatility, liquidity provision, private information

JEL Classification: F3, G12, G14, G15

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Date posted: November 6, 2009 ; Last revised: July 29, 2013

Suggested Citation

Chaboud, Alain and Chiquoine, Ben and Hjalmarsson, Erik and Vega, Clara, Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market (July 5, 2013). Journal of Finance, Forthcoming; FRB International Finance Discussion Paper No. 980. Available at SSRN: http://ssrn.com/abstract=1501135 or http://dx.doi.org/10.2139/ssrn.1501135

Contact Information

Alain Chaboud (Contact Author)
Federal Reserve Board - Division of International Finance ( email )
20th St. and Constitution Ave.
Washington, DC 20551
United States
(202) 452 3756 (Phone)
Ben Chiquoine
Federal Reserve Board - Division of International Finance ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
Erik Hjalmarsson
Queen Mary - University of London, School of Economics and Finance ( email )
Mile End Road
London, E1 4NS
United Kingdom
University of Gothenburg - Centre for Finance ( email )
Box 640
Gothenburg, 403 50
Sweden
Clara Vega
Board of Governors of the Federal Reserve System ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
HOME PAGE: http://www.federalreserve.gov/research/staff/vegaclarax.htm
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