The Costs of Latency
18 Pages Posted: 22 Aug 2014
Date Written: August 20, 2014
We derive the economic costs of latency induced by computer technology in trading. We show that the costs of latency are negligible in their expected value, but instead manifest themselves in increased risk to investors. We also show that our theoretical predictions firmly hold when tested on market data and that: 1) Faster trading communication does not lead to arms race in normal circumstances; 2) The cost of executing a trade (slippage) with as much as 1 minute latency is zero 80% of the time for some of the commonly traded financial instruments, but may vary from instrument to instrument; 3) The maximum cost a trader is willing to bear to reduce his latency by a certain time period can be quantified explicitly for different financial instruments.
Keywords: high-frequency, trading, microstructure, networks, speed, low-latency
JEL Classification: A13, C72, D44, D71, D81, D82, D83, G28, L1
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