Download this Paper Open PDF in Browser

What Is the Optimal Trading Frequency in Financial Markets?

Review of Economic Studies, Forthcoming

55 Pages Posted: 24 Oct 2016 Last revised: 24 Dec 2016

Songzi Du

Simon Fraser University (SFU) - Department of Economics

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: December 23, 2016

Abstract

This paper studies the impact of increasing trading frequency in financial markets on allocative efficiency. We build and solve a dynamic model of sequential double auctions in which traders trade strategically with demand schedules. Trading needs are generated by time-varying private information about the asset value and private values for owning the asset, as well as quadratic inventory costs. We characterize a linear equilibrium with stationary strategies and its efficiency properties in closed form. Frequent trading (more double auctions per unit of time) allows more immediate asset reallocation after new information arrives, at the cost of a lower volume of beneficial trades in each double auction. Under stated conditions, the trading frequency that maximizes allocative efficiency coincides with the information arrival frequency for scheduled information releases, but can far exceed the information arrival frequency if new information arrives stochastically. A simple calibration of the model suggests that a moderate market slowdown to the level of seconds or minutes per double auction can improve allocative efficiency for assets with relatively narrow investor participation and relatively infrequent news, such as small- and micro-cap stocks.

Keywords: trading frequency, allocative efficiency, high-frequency trading, double auction

JEL Classification: D44, D82, G14

Suggested Citation

Du, Songzi and Zhu, Haoxiang, What Is the Optimal Trading Frequency in Financial Markets? (December 23, 2016). Review of Economic Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2857674 or http://dx.doi.org/10.2139/ssrn.2857674

Songzi Du

Simon Fraser University (SFU) - Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

HOME PAGE: http://www.sfu.ca/~songzid

Haoxiang Zhu (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paper statistics

Downloads
466
Rank
51,263
Abstract Views
1,609