A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors
European Finance Association Annual Meetings 2014 Paper Series
53 Pages Posted: 25 Sep 2013 Last revised: 13 Oct 2015
Date Written: October 5, 2015
Abstract
The rapid growth of high frequency trading (HFT) has aroused considerable public attention and policy interests in its impact on institutional investors. Previous studies show that HFT decreases the average bid-ask spread. However, the major component of institutional trading costs is the price impact, as measured by the execution shortfall. Combining data on institutional trades and HFT trades, I find that HFT increases traditional institutional investors' trading costs. Specifically, one standard deviation increase in the intensity of HFT activities increases institutional execution shortfall costs by a third. I also perform various tests to rule out an alternative explanation that high frequency traders are attracted to stocks that have high trading costs. Further analysis suggests that HFT represents a short-lived and 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 traders engage in directional strategies. Additionally, I find that institutional trading skills can alleviate the adverse impact of HFT.
Keywords: High frequency trading, Institutional investors, Trading costs
JEL Classification: G10, G14, G23
Suggested Citation: Suggested Citation
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