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A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors

Lin Tong

Fordham University - Finance Area; University of Iowa - Department of Finance

November 2013

Combining data on high frequency trading (HFT) activities of a randomly selected sample of 120 stocks and data on institutional trades, I find that HFT increases the trading costs of traditional institutional investors. One standard deviation increase in the intensity of HFT activities increases institutional execution shortfall costs by a third. Further analysis suggests that HFT represents as an ephemeral and extra-expensive source of liquidity provision when demand and supply among institutional investors are imbalanced, and that the impact on institutional trading costs is most pronounced when high frequency (HF) traders engage in directional strategies (e.g., front-running). I perform various analyses to rule out an alternative explanation that HF traders are attracted to stocks that have high trading costs. First, HFT is most active on liquid stocks. Second, the results are robust to the controls for stable stock liquidity characteristics and events that might jointly affect HFT and trading costs. Third, an analysis of the HFT behavior around the temporary short selling ban in September 2008 highlights the opportunistic nature of liquidity provision by HF traders. Finally, Granger causality tests show that intensive HFT activity significantly contributes to institutional trading costs, but not vice versa.

Number of Pages in PDF File: 49

Keywords: High frequency trading, Institutional investors, Trading costs

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Date posted: September 25, 2013 ; Last revised: November 18, 2013

Suggested Citation

Tong, Lin, A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors (November 2013). Available at SSRN: http://ssrn.com/abstract=2330053 or http://dx.doi.org/10.2139/ssrn.2330053

Contact Information

Lin Tong (Contact Author)
Fordham University - Finance Area ( email )
33 West 60th Street
New York, NY 10023
United States
University of Iowa - Department of Finance ( email )
Iowa City, IA 52242-1000
United States
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