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Equilibrium Fast TradingBruno BiaisUniversity of Toulouse 1 - Toulouse School of Economics (TSE) Thierry FoucaultHEC Paris - Finance Department Sophie MoinasIAE - Université de Toulouse 1 Capitole; Toulouse School of Economics February 7, 2013 HEC Paris Research Paper No. 968/2013 AFA 2013 San Diego Meetings Paper Abstract: High-speed market connections and information processing improve nancial institutions'ability to seize trading opportunities, which raises gains from trade. They also enable fast traders to process information before slow traders, which generates adverse selection. We fi rst analyze trading equilibria for a given level of investment in fast-trading technology and then endogenize this level. Investments can be strategic substitutes or complements. In the latter case, investment waves can arise, where institutions invest in fast-trading technologies just to keep up with the others. When some traders become fast, it increases adverse selection costs for all, i.e., it generates negative externalities. Therefore equilibrium investment can exceed its welfare-maximizing counterpart.
Number of Pages in PDF File: 45 Keywords: high frequency trading, liquidity, welfare JEL Classification: G1 working papers seriesDate posted: March 19, 2012 ; Last revised: April 19, 2013Suggested CitationContact Information
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