Trading Fast and Slow: Colocation and Liquidity
University of Washington - Department of Finance and Business Economics
Stockholm University - Stockholm Business School
Lars L. Norden
Stockholm University - School of Business
Queen's School of Business
August 05, 2015
Forthcoming in Review of Financial Studies
We exploit an optional colocation upgrade at NASDAQ OMX Stockholm to assess how speed affects market liquidity. Liquidity improves for the overall market and even for noncolocated trading entities. We find that the upgrade is pursued mainly by participants who engage in market making. Those that upgrade use their enhanced speed to reduce their exposure to adverse selection and to relax their inventory constraints. In particular, the upgraded trading entities remain competitive at the best bid and offer even when their inventories are in their top decile. Our results suggest that increasing the speed of market-making participants benefit market liquidity.
Number of Pages in PDF File: 57
Keywords: colocation, high-frequency trading, liquidity, fast trading, proximity services
JEL Classification: G14, G15, L10
Date posted: August 30, 2013 ; Last revised: August 28, 2015
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