High-Frequency Trading Synchronizes Prices in Financial Markets

28 Pages Posted: 10 Nov 2012 Last revised: 20 Jan 2015

Austin Gerig

U.S. Securities and Exchange Commission

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

Gerig, Austin, High-Frequency Trading Synchronizes Prices in Financial Markets (January 1, 2015). Available at SSRN: https://ssrn.com/abstract=2173247 or http://dx.doi.org/10.2139/ssrn.2173247

Austin Gerig (Contact Author)

U.S. Securities and Exchange Commission ( email )

United States Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
United States
202-551-4575 (Phone)

HOME PAGE: http://www.austingerig.com

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