Who Provides Liquidity and When?

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

64 Pages Posted: 21 Jan 2017 Last revised: 3 Feb 2019

See all articles by Sida Li

Sida Li

University of Illinois at Urbana-Champaign

Xin Wang

Nanyang Technological University (NTU) - Division of Banking & Finance

Mao Ye

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

Date Written: January 1, 2019

Abstract

We model competition for liquidity provision between high-frequency traders (HFTs) and slower execution algorithms designed to minimize transaction costs for buy-side institutions (B-Algos). Under continuous pricing, B-Algos dominate liquidity provision by using aggressive limit orders to stimulate HFTs’ market orders. Under discrete pricing, HFTs dominate liquidity provision if the bid–ask spread is binding at one tick. If the tick size is not binding, B-Algos choose between stimulating HFTs and providing liquidity to other non-HFTs. Flash crashes arise under certain parameter values. Transaction costs can be negatively correlated with the bid–ask spread when all traders can provide liquidity.

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? (January 1, 2019). 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

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-B1B-76 Nanyang Avenue
Singapore, 639798
Singapore
+6593816646 (Phone)

HOME PAGE: http://https://www.financexinwang.com/

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

Register to save articles to
your library

Register

Paper statistics

Downloads
253
rank
116,474
Abstract Views
1,434
PlumX Metrics