Equilibrium Fast Trading
University of Toulouse 1 - Toulouse School of Economics (TSE)
HEC Paris - Finance Department
IAE - 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
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: G1working papers series
Date posted: March 19, 2012 ; Last revised: April 19, 2013
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