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
January 6, 2015
Western Finance Association (WFA), 2011
A limit order market enables an early seller to trade with a late buyer by leaving a price quote. Information arrival in the interim period creates adverse selection risk for the seller and therefore hampers trade. Entry of high-frequency traders (HFTs) might restore trade as their machines can refresh quotes quickly on (hard) information. Empirically, HFT entry reduced adverse selection by 23% and increased trade by 17%. Model calibration shows that one percentage point more of the gains from trade were realized. Finally, we show that a well-designed double auction raises this to ten percentage points.
Number of Pages in PDF File: 50
Keywords: high-frequency trading, welfare, liquidity, middleman
JEL Classification: G00
Date posted: June 13, 2010 ; Last revised: January 7, 2015
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