High-Frequency Trading Synchronizes Prices in Financial Markets
28 Pages Posted: 10 Nov 2012 Last revised: 20 Jan 2015
Date Written: January 1, 2015
Abstract
High-speed computerized trading, often called "high-frequency trading" (HFT), has increased dramatically in financial markets over the last decade. In the US and Europe, it now accounts for nearly one-half of all trades. Although evidence suggests that HFT contributes to the efficiency of markets, there are concerns it also adds to market instability, especially during times of stress. Currently, it is unclear how or why HFT produces these outcomes. In this paper, I use data from NASDAQ to show that HFT synchronizes prices in financial markets, making the values of related securities change contemporaneously. With a model, I demonstrate how price synchronization leads to increased efficiency: prices are more accurate and transaction costs are reduced. During times of stress, however, localized errors quickly propagate through the financial system if safeguards are not in place. In addition, there is potential for HFT to enforce incorrect relationships between securities, making prices more (or less) correlated than economic fundamentals warrant. This research highlights an important role that HFT plays in markets and helps answer several puzzling questions that previously seemed difficult to explain: why HFT is so prevalent, why HFT concentrates in certain securities and largely ignores others, and finally, how HFT can lower transaction costs yet still make profits.
Keywords: Algorithmic Trading, Automated Trading, High Frequency Trading, Market Making, Specialist, Statistical Arbitrage
JEL Classification: G14, G19
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Does Algorithmic Trading Improve Liquidity?
By Terrence Hendershott, Charles M. Jones, ...
-
The Flash Crash: High-Frequency Trading in an Electronic Market
By Andrei A. Kirilenko, Albert S. Kyle, ...
-
By Joel Hasbrouck and Gideon Saar
-
Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market
By Alain Chaboud, Ben Chiquoine, ...
-
Automation, Speed, and Stock Market Quality: The NYSE’s Hybrid
-
Equilibrium High Frequency Trading
By Thierry Foucault, Sophie Moinas, ...
-
Insiders-Outsiders, Transparency, and the Value of the Ticker
By Giovanni Cespa and Thierry Foucault
-
Insiders-Outsiders, Transparency and the Value of the Ticker
By Giovanni Cespa and Thierry Foucault