Competition for Order Flow with Fast and Slow Traders
The Review of Financial Studies, 28(7), 2094-2127
51 Pages Posted: 15 Mar 2012 Last revised: 14 Jan 2020
Date Written: Jan 1, 2015
The rise of computerized trading strategies in equity markets has spurred competition between trading venues. This paper shows that cross-venue strategies create highly interlinked markets: trades on one venue are followed by sizeable cancellations of limit orders on competing venues. These cancellations are explained in a simple model of competition between two limit order markets with fast and slow traders. Only the fast traders can access the liquidity of both venues simultaneously. Empirically, we confirm the predictions that the fraction of fast traders (i) reduces the equilibrium liquidity supply and (ii) reduces the magnitude of the cancellations following a trade.
Keywords: Market microstructure, Fragmentation, Market makers, High Frequency Trading
JEL Classification: G10, G14, G15
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