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

See all articles by Lin Tong

Lin Tong

Fordham University - Finance Area

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

Tong, Lin, A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors (October 5, 2015). European Finance Association Annual Meetings 2014 Paper Series, Available at SSRN: https://ssrn.com/abstract=2330053 or http://dx.doi.org/10.2139/ssrn.2330053

Lin Tong (Contact Author)

Fordham University - Finance Area ( email )

33 West 60th Street
New York, NY 10023
United States

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