Liquidity with High-Frequency Market Making
12 Pages Posted: 27 Mar 2014 Last revised: 28 Mar 2014
Date Written: March 26, 2014
We study a simple model of market making in which high-frequency market makers can cancel limit orders quickly after receiving an adverse signal. The resulting winner's curse induces low-frequency market makers to widen bid-ask spreads. Liquidity in the market may deteriorate unless high-frequency market makers fully replace low-frequency market makers in liquidity provision. Our result suggests that some restrictions on high-frequency trading, such as minimum resting times, may improve market liquidity by leveling the playing field among market makers with different speeds.
Keywords: high-frequency trading, market making, order cancellation, bid-ask spread, winner's curse, informed trading
JEL Classification: D82, G14, G18
Suggested Citation: Suggested Citation