Equilibrium Fast Trading
57 Pages Posted: 19 Mar 2012 Last revised: 23 Feb 2018
Date Written: March 27, 2014
High-speed market connections and information processing improve the ability to seize trading opportunities, raising gains from trade. They also enable fast traders to process information before slow traders, generating adverse selection, and thus negative externalities. When investing in fast-trading technologies, institutions do not internalize these externalities. Accordingly, they overinvest in equilibrium. Completely banning fast trading is dominated by offering two platforms: one accepting fast traders, the other banning them. Utilitarian welfare is maximized by having i) a single platform on which fast and slow traders coexist and ii) Pigovian taxes on investment in the fast-trading technology.
Keywords: high frequency trading, liquidity, welfare, adverse selection, investment
JEL Classification: G1
Suggested Citation: Suggested Citation