Liquidity Suppliers and High Frequency Trading

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Philip Protter

Columbia University

December 12, 2013

This paper provides a mathematical analysis of how high frequency traders profi t from their speed with respect to the limit order book. We show that their pro ts can be decomposed into two components. The rest is due to their ability to execute market orders at limit order prices and without incurring any liquidity costs themselves. The second is by "front running" market orders with limit prices. These trading profi ts are shown to be at the expense of ordinary traders who submit market orders and sophisticated traders who submit limit orders or who use algorithmic trading to split up and execute large trades. We do not consider the welfare implications of our insights to the efficient functioning of financial markets.

Number of Pages in PDF File: 13

Keywords: High frequency trading, liquidity costs, front running, martingale measures, trading strategies

JEL Classification: G10, G12, G14, G19

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Date posted: December 15, 2013  

Suggested Citation

Jarrow, Robert A. and Protter, Philip, Liquidity Suppliers and High Frequency Trading (December 12, 2013). Available at SSRN: http://ssrn.com/abstract=2367381 or http://dx.doi.org/10.2139/ssrn.2367381

Contact Information

Robert A. Jarrow
Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )
Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Philip Protter (Contact Author)
Columbia University ( email )
Mail Code 4403
New York, NY 10027
United States
2128511245 (Phone)
2128512164 (Fax)
HOME PAGE: http://www.stat.columbia.edu/~protter/
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