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Equilibrium Fast Trading

57 Pages Posted: 19 Mar 2012 Last revised: 4 Sep 2014

Bruno Biais

University of Toulouse 1 - Toulouse School of Economics (TSE)

Thierry Foucault

HEC Paris - Finance Department

Sophie Moinas

Toulouse School of Economics

Date Written: August 2014

Abstract

High-speed market connections improve investors' ability to search for attractive quotes in fragmented markets, raising gains from trade. They also enable fast traders to observe market 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 types of markets: one accepting fast traders, the other banning them. However, utilitarian welfare is maximized by having i) a single market type 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, D4, D62, G20, L1

Suggested Citation

Biais, Bruno and Foucault, Thierry and Moinas, Sophie, Equilibrium Fast Trading (August 2014). AFA 2013 San Diego Meetings Paper; HEC Paris Research Paper No. 968/2013. Available at SSRN: https://ssrn.com/abstract=2024360 or http://dx.doi.org/10.2139/ssrn.2024360

Bruno Biais (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Thierry Foucault

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
(33)139679569 (Phone)
(33)139677085 (Fax)

HOME PAGE: http://thierryfoucault.com/

Sophie Moinas

Toulouse School of Economics ( email )

Toulouse 1 Capitole University
Place Anatole-France
Toulouse Cedex, F-31042
France

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