Competition among High-Frequency Traders, and Market Quality

Abstract

I study empirically how competition among high-frequency traders (HFTs) affects their trading behavior and market quality. The analysis exploits a unique dataset, which allows comparing environments with and without high-frequency competition, and contains an exogenous event - a tick size reform - which I use to separate the effects of high-frequency trading competition from the effects of the rising share of high-frequency trading in the market. I find that when HFTs compete, their speculative trading increases. As a result, market liquidity deteriorates and short-term volatility rises. My findings hold for a variety of market quality and high-frequency trading behavior measures.

Keywords: high-frequency trading, competition, high-frequency trading strategies, tick size reform

JEL Classification: G12, G14, G15, G18, G23, D4, D61