High Frequency Trading and Price Discovery

61 Pages Posted: 12 Oct 2011 Last revised: 26 Apr 2013

See all articles by Jonathan Brogaard

Jonathan Brogaard

University of Utah - David Eccles School of Business

Terrence Hendershott

University of California, Berkeley - Haas School of Business

Ryan Riordan

Queen's University - Smith School of Business; Ludwig-Maximilians-University Munich, Faculty of Business Administration (Munich School of Management)

Date Written: April 22, 2013

Abstract

We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.

Keywords: high frequency trading, price formation, price discovery, pricing errors

JEL Classification: G12

Suggested Citation

Brogaard, Jonathan and Hendershott, Terrence J. and Riordan, Ryan, High Frequency Trading and Price Discovery (April 22, 2013). Available at SSRN: https://ssrn.com/abstract=1928510 or http://dx.doi.org/10.2139/ssrn.1928510

Jonathan Brogaard

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

HOME PAGE: http://www.jonathanbrogaard.com

Terrence J. Hendershott

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Ryan Riordan (Contact Author)

Queen's University - Smith School of Business ( email )

Smith School of Business, Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Ludwig-Maximilians-University Munich, Faculty of Business Administration (Munich School of Management) ( email )

Schackstr. 4
Munich, 80539
Germany

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