High Frequency Trading and Price Discovery
University of Washington - Department of Finance and Business Economics
University of California, Berkeley - Haas School of Business
University of Ontario Institute of Technology - Faculty of Business and Information Technology
July 30, 2012
AFA 2013 San Diego Meetings Paper
We examine the role of high-frequency traders (HFT) in price discovery and price efficiency. Overall HFT facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors on average days and the highest volatility days. This is done through their marketable orders. In contrast, HFT liquidity-supplying non-marketable orders are adversely selected in terms of the permanent and transitory components as these trades are in the direction opposite to permanent price changes and in the same direction as transitory pricing errors. HFT predicts price changes in the overall market over short horizons measured in seconds. HFT is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.
Number of Pages in PDF File: 45
Keywords: high frequency trading, price formation, price discovery, pricing errors
JEL Classification: G12working papers series
Date posted: July 20, 2012 ; Last revised: August 1, 2012
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