Market Microstructure and the Risks of High-Frequency Trading

53 Pages Posted: 18 Jul 2013 Last revised: 20 Aug 2013

See all articles by Irene Aldridge

Irene Aldridge

AbleMarkets.com; Cornell University; BigDataFinance.org; ABLE Alpha Trading, LTD

Date Written: August 19, 2013

Abstract

The current research assesses the risks commonly attributed to the presence of HFT in the context of different market structures deployed by the U.S. exchanges. In particular, we find that, by design, the so-called “normal” exchanges have the lowest market quality, including the highest proportion of limit orders cancelled, the lowest ability to detect spoofing market manipulation, the highest volatility and probability of market crashes, yet the highest liquidity. The so-called “inverted” exchanges have higher market quality, including a lower proportion of limit orders cancelled, higher ability to detect spoofing market manipulation, lower volatility and probability of market crashes, but lower liquidity levels. Finally, we show that “pro-rata” markets possess even higher market quality. We derive these results theoretically and then show that they hold empirically. We also derive the theoretical quality of markets with no-cancel ranges, and optimal order sizes in pro-rata markets.

Keywords: high-frequency trading, market, microstructure, exchanges, matching, pro-rata, price-time priority, market manipulation

JEL Classification: D4, D82, G12, G14, G15, G18, L11, O33, O38

Suggested Citation

Aldridge, Irene, Market Microstructure and the Risks of High-Frequency Trading (August 19, 2013). Available at SSRN: https://ssrn.com/abstract=2294526 or http://dx.doi.org/10.2139/ssrn.2294526

Irene Aldridge (Contact Author)

AbleMarkets.com ( email )

New York, NY 10128
United States

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

Cornell University ( email )

Ithaca, NY 14853
United States

BigDataFinance.org ( email )

United States

ABLE Alpha Trading, LTD ( email )

New York, NY 10004
United States

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

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