Liquidity with High-Frequency Market Making

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

Han, Jungsuk and Khapko, Mariana and Kyle, Albert (Pete) S., Liquidity with High-Frequency Market Making (March 26, 2014). Swedish House of Finance Research Paper No. 14-06, Available at SSRN: https://ssrn.com/abstract=2416396 or http://dx.doi.org/10.2139/ssrn.2416396