Abstract

http://ssrn.com/abstract=2066839
 
 

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The Externalities of High Frequency Trading


Mao Ye


University of Illinois at Urbana-Champaign

Chen Yao


University of Warwick - Warwick Business School; University of Warwick

Jiading Gai


University of Illinois at Urbana-Champaign

August 7, 2013


Abstract:     
When price competition is constrained by tick size, speed allocates the resources due to the time priority rule. We demonstrate three implications of competition in speed. 1) We find more high frequency liquidity provision for lower price stocks with high market cap, where the one cent tick size has a higher constraint on price competition. 2) Speed has no impact on (the price) of liquidity, because speed competition already implies that liquidity providers cannot undercut each other’s price. We find that exogenous technology improvements improving speed at a one millisecond, microsecond or nanosecond level do not lead to improvements on quoted spread, effective spread, trading volume or variance ratio. However, the cancellation/execution ratio increases, short term volatility increases and market depth decreases. 3) It is relative speed that matters. We find evidence consistent with the quote stuffing hypothesis (Biais and Woolley, 2011) using NASDAQ channel assignment as identification. Competition in speed but not price leads to externalities based on the canonical definition of Laffont (2008). One possible policy solution is the deregulation of tick size or decrease the importance of time priority.

Number of Pages in PDF File: 56

Keywords: Externality, Positional Game, High-Frequency Trading, Liquidity, Price Efficiency, Quote Stuffing , Supercomputing

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Date posted: May 26, 2012 ; Last revised: March 18, 2014

Suggested Citation

Ye, Mao and Yao, Chen and Gai, Jiading, The Externalities of High Frequency Trading (August 7, 2013). Available at SSRN: http://ssrn.com/abstract=2066839 or http://dx.doi.org/10.2139/ssrn.2066839

Contact Information

Mao Ye (Contact Author)
University of Illinois at Urbana-Champaign ( email )
406 Wohlers
1206 South 6th Street
Champaign, IL 61820
United States
2172440474 (Phone)
Chen Yao
University of Warwick - Warwick Business School ( email )
Coventry CV4 7AL
United Kingdom
University of Warwick ( email )
Warwick Business School
Gibbet Hill Road
Coventry, West Midlands CV47AL
United Kingdom
+44 024 7652 2828 (Phone)
Jiading Gai
University of Illinois at Urbana-Champaign ( email )
601 E John St
Champaign, IL 61820
United States
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