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High-Frequency Trading, Stock Volatility, and Price Discovery

54 Pages Posted: 14 Oct 2010 Last revised: 27 Dec 2010

Frank Zhang

Yale School of Management

Date Written: December 2010

Abstract

High-frequency trading has become a dominant force in the U.S. capital market, accounting for over 70% of dollar trading volume. This study examines the implication of high-frequency trading for stock price volatility and price discovery. I find that high-frequency trading is positively correlated with stock price volatility after controlling for firm fundamental volatility and other exogenous determinants of volatility. The positive correlation is stronger among the top 3,000 stocks in market capitalization and among stocks with high institutional holdings. The positive correlation is also stronger during periods of high market uncertainty. Furthermore, I find that high-frequency trading is negatively related to the market’s ability to incorporate information about firm fundamentals into asset prices. Stock prices tend to overreact to fundamental news when high-frequency trading is at a high volume. Overall, this paper demonstrates that high-frequency trading may potentially have some harmful effects for the U.S. capital market.

Keywords: High-frequency trading, trading volume, volatility, return, price discovery

JEL Classification: G10, G11, G12, G14, G23, M40, M41

Suggested Citation

Zhang, Frank, High-Frequency Trading, Stock Volatility, and Price Discovery (December 2010). Available at SSRN: https://ssrn.com/abstract=1691679 or http://dx.doi.org/10.2139/ssrn.1691679

Frank Zhang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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