Maker-Taker Fee, Liquidity Competition, and High Frequency Trading

41 Pages Posted: 20 Aug 2016

See all articles by Yiping Lin

Yiping Lin

Capital Markets CRC Limited (CMCRC)

Peter L. Swan

University of New South Wales (UNSW Sydney; Financial Research Network (FIRN)

Frederick H. deB. Harris

Wake Forest University; Capital Markets CRC Limited (CMCRC)

Date Written: August 18, 2016

Abstract

This paper analyzes how a maker-taker fee reduction affects market competition, liquidity, and high frequency trading. The purposes are threefold:

1) whether reducing the exchange maker-taker fee attracts liquidity from off-exchange venues;

2) holding the net exchange fee relatively constant, whether the components of the maker-taker fee change matter; and

3) how HFT responds to the rebate/fee change.

By using the Nasdaq maker-taker fee experiment and difference-in-differences methodology, we find that the unilateral maker-taker fee reduction in one lit exchange did not gain market share from off-exchange trading venues; instead, a redistribution of market share among existing lit exchanges occurred. Overall, market share shifted from Nasdaq to other lit exchanges with the highest rebate payment. The experiment demonstrates that in addition to the net fee, the components of the maker-taker fee change matter in competitive fragmented markets. The reduced maker rebate lowers quote quality and the percentage of incoming orders routed to Nasdaq. However, in an offsetting manner, it improves the fill rate and speed of fill because of the reduced taker fee. Further, market efficiency declines. Thanks to the improved relative position of a market in routing tables, adverse selection costs thus decline. This raises standard measures of market liquidity, while liquidity supplier profits decrease. As the fee and rebate reduce, high frequency traders tend to switch from adding to removing liquidity.

Keywords: High Frequency Trading, Liquidity, Maker-Taker Fee, Market Fragmentation, Market Efficiency

JEL Classification: G12, G14

Suggested Citation

Lin, Yiping and Swan, Peter Lawrence and Harris, Frederick (Rick) H. deB., Maker-Taker Fee, Liquidity Competition, and High Frequency Trading (August 18, 2016). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2826376 or http://dx.doi.org/10.2139/ssrn.2826376

Yiping Lin (Contact Author)

Capital Markets CRC Limited (CMCRC) ( email )

Level 2, 55 Harrington Street, The Rocks
Sydney, 2000
Australia

Peter Lawrence Swan

University of New South Wales (UNSW Sydney ( email )

School of Banking and Finance
UNSW Business School
Sydney NSW, NSW 2052
Australia
+61 2 9385 5871 (Phone)
+61 2 9385 6347 (Fax)

HOME PAGE: http://https://www.business.unsw.edu.au/our-people/peterswan

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Frederick (Rick) H. deB. Harris

Wake Forest University ( email )

2601 Wake Forest Road
Babcock Graduate School of Management
Winston-Salem, NC 27109
United States
336-758-5112 (Phone)

Capital Markets CRC Limited (CMCRC) ( email )

Level 3, 55 Harrington Street
Sydney, 2000
Australia

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