Need for Speed? Exchange Latency and Liquidity
Review of Financial Studies (Forthcoming)
52 Pages Posted: 28 May 2014 Last revised: 23 Mar 2017
Date Written: September 28, 2016
Speeding up the exchange does not necessarily improve liquidity. On the one hand, more speed enables a high-frequency market maker (HFM) to update his quotes faster on incoming news. This reduces his payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet speculative high-frequency bandits, thus less likely to meet liquidity traders. This raises the spread. The net effect depends on a security’s news-to-liquidity-trader ratio.
Keywords: Exchange Speed, High-Frequency Trading, Information Asymmetry
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation