Competition among Liquidity Providers with Access to High-Frequency Trading Technology
89 Pages Posted: 4 Dec 2015 Last revised: 4 Feb 2020
Date Written: February 4, 2020
We model endogenous technology adoption and competition among liquidity providers with access to High-Frequency Trading (HFT) technology. HFT technology provides speed and informational advantages. Information advantages may restore excessively toxic markets. Speed technology may reduce resource costs for liquidity provision. Both effects increase liquidity and welfare. However, informationally advantaged HFTs may impose a winner's curse on traditional market makers, who in response reduce their participation. This increases resource costs and lowers the execution likelihood for market orders, thereby reducing liquidity and welfare. This result also holds when HFT dominates traditional technology in terms of costs and informational advantages.
Keywords: Adverse Selection, Liquidity, Latency, Informed Trading, Trading Technology
JEL Classification: D53, G01, G10, G18
Suggested Citation: Suggested Citation