Does Algorithmic Trading Improve Liquidity?
WFA 2008 Paper
54 Pages Posted: 5 Mar 2008 Last revised: 27 Jul 2011
Date Written: August 30, 2010
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.
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