Middlemen in Limit-Order Markets
New York University - Department of Economics
Albert J. Menkveld
VU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA); Duisenberg School of Finance
November 8, 2012
Western Finance Association (WFA), 2011
A limit-order market enables an early seller to trade with a late buyer by leaving a price quote. But, public news in the interarrival period creates adverse selection for the seller and therefore hampers trade. Machines, operated by high-frequency traders (HFTs), might restore trade by bringing the capacity to quickly update quotes on news. A theoretical model shows that HFT entry can indeed increase welfare, but it might also reduce it. Empirically, HFT entry coincided with a 23% drop in adverse-selection cost on price quotes and a 17% increase in trade frequency. Model calibration reveals a modest welfare increase.
Number of Pages in PDF File: 58
Keywords: high-frequency trading, welfare, liquidity, middleman
JEL Classification: G00working papers series
Date posted: June 13, 2010 ; Last revised: November 8, 2012
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