High Frequency Traders: Taking Advantage of Speed
Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
University of Cincinnati - Department of Finance - Real Estate
May 15, 2014
We propose a model of dynamic trading where a strategic high frequency trader receives an imperfect signal about the future order flow, and exploits his speed advantage to act as a market maker. We determine the provision of liquidity, order cancellations, and impact on low frequency traders. The model predicts that volatility leads high frequency traders to reduce their provision of liquidity. Next, we analyze the problem when the high frequency trader competes with another market maker. Finally, we provide the first formal, model-based analysis of the impact of various policies designed to regulate high frequency trading.
Number of Pages in PDF File: 56
Keywords: High Frequency Trading, Market Making, Liquidity, Order Cancellations, Competition for Order Flow, Tobin Tax, Order Resting Time, Order Cancellation Tax
JEL Classification: G10
Date posted: September 28, 2013 ; Last revised: May 16, 2014
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