High-Frequency Trading in Limit Order Markets: Equilibrium Impact and Regulation

47 Pages Posted: 1 Jul 2015 Last revised: 11 Mar 2016

See all articles by Jakub Rojcek

Jakub Rojcek

University of Zurich, Department of Banking and Finance; Swiss Finance Institute

Alexandre Ziegler

University of Zurich - Department of Banking and Finance

Date Written: March 09, 2016

Abstract

We investigate the impact of high-frequency trading (HFT) on market quality and investor welfare using a general limit order book model. We find that while the presence of HFT always improves market quality under symmetric information, under asymmetric information this is the case only if competition between high-frequency traders is sufficiently strong. While HFT does not negatively impact investor welfare, it reduces the welfare of slow speculators. The flexibility of the model allows investigating the effect of the main recent regulatory initiatives designed to curb HFT on market quality and investor welfare. We consider time-in-force rules, cancellation fees, transaction taxes, rebate fee structures, and speed bumps. While some of these regulations lead to improvements in a number of market quality measures, this generally does not translate into higher welfare for long-term investors. Rather, the main effect of such regulations is to generate wealth transfers from high-frequency traders to slow speculators. These regulations therefore appear inadequate to enhance investor welfare in the presence of HFTs. Of the different measures, transaction taxes are the least harmful; while they reduce welfare roughly by the amount of the tax, they do not significantly worsen market quality. The common practice by exchanges of granting rebates to limit orders is detrimental to market quality and investor welfare, causing both higher effective spreads and longer execution times.

Keywords: High-frequency trading, Regulation, Market quality

JEL Classification: G14, G28, C63, C73, D82

Suggested Citation

Rojcek, Jakub and Ziegler, Alexandre, High-Frequency Trading in Limit Order Markets: Equilibrium Impact and Regulation (March 09, 2016). Swiss Finance Institute Research Paper No. 15-23. Available at SSRN: https://ssrn.com/abstract=2624639 or http://dx.doi.org/10.2139/ssrn.2624639

Jakub Rojcek

University of Zurich, Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Alexandre Ziegler (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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