High Frequency Trading and Price Discovery
61 Pages Posted: 12 Oct 2011 Last revised: 26 Apr 2013
Date Written: April 22, 2013
We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.
Keywords: high frequency trading, price formation, price discovery, pricing errors
JEL Classification: G12
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