Who Provides Liquidity and When: An Analysis of Price vs. Speed Competition on Liquidity and Welfare
61 Pages Posted: 21 Jan 2017 Last revised: 13 Nov 2017
Date Written: September 30, 2017
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: Suggested Citation