Order Flow Segmentation, Liquidity and Price Discovery: The Role of Latency Delays

Abstract

Latency delays — known as “speed bumps” — slow the execution of orders at an exchange, often to protect market makers against latency arbitrage. We study informed trading in a fragmented market, where one exchange introduces a latency delay on market orders. While liquidity improves at the delayed exchange and overall exchange volume increases, the delay concentrates informed trading at the conventional exchange, where liquidity worsens. This segmentation may improve price discovery when the frequency of liquidity trading is relatively high, at the expense of lower investor welfare; however, the reverse is true for relatively low liquidity trading.

Keywords: latency delays, speed bumps, market fragmentation, asymmetric information

JEL Classification: G14, G18