Who Provides Liquidity and When?

Finance Down Under 2018 Building on the Best from the Cellars of Finance Paper

61 Pages Posted: 21 Jan 2017 Last revised: 12 May 2018

Sida Li

University of Illinois at Urbana-Champaign

Xin Wang

University of Illinois at Urbana-Champaign

Mao Ye

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Date Written: September 30, 2017

Abstract

We incorporate discrete tick size and allow non-high-frequency traders (non-HFTs) to supply liquidity in the framework of Budish, Cramton, and Shin (2015). When adverse selection risk is low or tick size is large, the bid-ask spread is typically below one tick, and HFTs dominate liquidity supply. In other situations, non-HFTs dominate liquidity supply by undercutting HFTs, because supplying liquidity to HFTs is always less costly than demanding liquidity from HFTs. A small tick size improves liquidity, but also leads to more mini-flash crashes. The cancellation-to-trade ratio, a popular proxy for HFTs, can have a negative correlation with HFTs’ activity.

Keywords: Algorithmic trading, High-frequency trading, Liquidity, Tick Size

JEL Classification: G10, G20

Suggested Citation

Li, Sida and Wang, Xin and Ye, Mao, Who Provides Liquidity and When? (September 30, 2017). Finance Down Under 2018 Building on the Best from the Cellars of Finance Paper. Available at SSRN: https://ssrn.com/abstract=2902984 or http://dx.doi.org/10.2139/ssrn.2902984

Sida Li

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

Xin Wang

University of Illinois at Urbana-Champaign ( email )

214 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States

Mao Ye (Contact Author)

University of Illinois at Urbana-Champaign ( email )

406 Wohlers
1206 South 6th Street
Champaign, IL 61820
United States
2172440474 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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