Every Cloud Has a Silver Lining: Fast Trading, Microwave Connectivity and Trading Costs
51 Pages Posted: 6 Oct 2016
Date Written: October 2016
In modern markets, trading firms spend generously to gain a speed advantage over their rivals. The marketplace that results from this rivalry is characterized by speed differentials, whereby some traders are faster than others. Is such a marketplace optimal? To answer this question, we study a series of exogenous weather-related episodes that temporarily remove speed advantages of the fastest traders by disrupting their microwave networks. During these episodes, adverse selection declines accompanied by improved liquidity and reduced volatility. Liquidity improvement is larger than the decline in adverse selection consistent with the emergence of latent liquidity and enhanced competition among liquidity suppliers. The results are confirmed in an event-study setting, whereby a new business model adopted by one of the technology providers reduces speed differentials among traders, resulting in liquidity improvements.
Keywords: Liquidity, Speed Differentials, Microwave Connectivity
JEL Classification: G10, G14
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