Does Algorithmic Trading Improve Liquidity?

54 Pages Posted: 5 Mar 2008 Last revised: 27 Jul 2011

See all articles by Terrence Hendershott

Terrence Hendershott

University of California, Berkeley - Haas School of Business

Charles M. Jones

Columbia University

Albert J. Menkveld

Vrije Universiteit Amsterdam

Date Written: August 30, 2010

Abstract

Algorithmic trading has sharply increased over the past decade. Does it improve market quality, and should it be encouraged? We provide the first analysis of this question. The NYSE automated quote dissemination in 2003, and we use this change in market structure that increases algorithmic trading as an exogenous instrument to measure the causal effect of algorithmic trading on liquidity. For large stocks in particular, algorithmic trading narrows spreads, reduces adverse selection, and reduces trade-related price discovery. The findings indicate that algorithmic trading improves liquidity and enhances the informativeness of quotes.

Suggested Citation

Hendershott, Terrence J. and Jones, Charles M. and Menkveld, Albert J., Does Algorithmic Trading Improve Liquidity? (August 30, 2010). Journal of Finance, Vol. 66, pp. 1-33, WFA 2008 Paper, Available at SSRN: https://ssrn.com/abstract=1100635

Terrence J. Hendershott

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Charles M. Jones

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Albert J. Menkveld (Contact Author)

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands
+31 20 5986130 (Phone)
+31 20 5986020 (Fax)

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