Liquidity Measure Distortions in Fast Markets: Expensive and Cheap Solutions

Abstract:     
We investigate how the increase in speed of U.S. equity markets has distorted liquidity measures. We find that the widely-used Monthly Trade and Quote (MTAQ) database yields a percent effective spread 43% higher than our benchmark, a quoted spread that is nonpositive nine times more often, and a potential cost of poor routing decisions of $8.4 Billion/year. We test ways to eliminate or mitigate these distortions. We find that the best solution is to use the expensive Daily Trade and Quote database. If a researcher is financially constrained, then the second best solution is to use MTAQ with our new Interpolated Time technique and two other techniques.

Number of Pages in PDF File: 48

Keywords: millisecond, high-frequency trading, low-latency trading, NBBO, DTAQ, MTAQ, TAQ

JEL Classification: C15, G12, G20

working papers series