Middlemen in Limit Order Markets
56 Pages Posted: 13 Jun 2010 Last revised: 21 Jun 2016
Date Written: June 20, 2016
A limit order market enables an early seller to trade with a late buyer by leaving a price quote. Information arrival in the interim period creates adverse selection risk for the seller and therefore hampers trade. Entry of high-frequency traders (HFTs) might restore trade as their machines can refresh quotes quickly on (hard) information. Empirically, HFT entry reduced adverse selection by 23% and increased trade by 17%. Model calibration shows that one percentage point more of the gains from trade were realized. Finally, we show that a well-designed double auction raises this to ten percentage points.
Keywords: high-frequency trading, welfare, liquidity, middleman
JEL Classification: G00
Suggested Citation: Suggested Citation