Pick Your Poison — Fragmentation or Market Power? An Analysis of Regnms, High Frequency Trading, and Securities Market Structure

9 Pages Posted: 9 Jul 2014

See all articles by Craig Pirrong

Craig Pirrong

University of Houston - Department of Finance

Date Written: Spring 2014

Abstract

The publication of Michael Lewis's has intensified an already contentious debate over high frequency trading (HFT). But the causes that have given rise to HFT are more complicated — and the general economic consequences far more positive — than at least the popular accounts (including Lewis's own) of the book would suggest. While directing much of its attention to the powerful computers and “predatory” potential of HFT, the “media” version of Lewis's book has all but ignored the fundamental driver of such activity: the implementation in 2007 of SEC Regulation NMS, which required all exchanges to direct their orders to the exchanges with the best prices. Before RegNMS, U.S. equity trading was largely dominated by NYSE and Nasdaq. The major exchanges' effective “ownership” of their order flow gave exchange specialists significant edges in trading. RegNMS has resulted in the proliferation of competing stock exchanges, which in turn has dramatically reduced both trading costs and the economic franchise value enjoyed by institutional traders associated with the previously dominant exchanges. The balance of evidence strongly indicates that the cost of trading has declined for retail traders and investors. The big losers have been the previously advantaged wholesale traders. HFT is simply one of the outcomes of the new, more competitive trading environment created by Regulation NMS.

Suggested Citation

Pirrong, Craig, Pick Your Poison — Fragmentation or Market Power? An Analysis of Regnms, High Frequency Trading, and Securities Market Structure (Spring 2014). Journal of Applied Corporate Finance, Vol. 26, Issue 2, pp. 8-14, 2014. Available at SSRN: https://ssrn.com/abstract=2463902 or http://dx.doi.org/10.1111/jacf.12061

Craig Pirrong (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States

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