High Frequency Market Making: Implications for Liquidity

45 Pages Posted: 2 Feb 2017

See all articles by Yacine Ait-Sahalia

Yacine Ait-Sahalia

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Mehmet Saglam

University of Cincinnati - Department of Finance - Real Estate

Date Written: January 30, 2017

Abstract

We analyze the consequences for liquidity provision of competing market makers operating at high frequency. Competition increases overall liquidity and deters the fast market maker’s use of order flow signals. Using various liquidity metrics, we find that the market maker provides more liquidity as he gets faster but shies away from it as volatility increases. We then provide a model-based analysis of the impact of four widely discussed policies designed to regulate high frequency trading: imposing a transactions tax, setting minimum-time limits before quotes can be cancelled, taxing the cancellations of limit orders, and replacing time priority with a pro rata or random allocation. We find that these policies are largely unable to induce high frequency market makers to provide liquidity that is robust across volatility events

Keywords: High Frequency Trading, Market Making, Duopoly, Liquidity, Order Cancellations, Competition for Order Flow, Financial Market Regulation, Tobin Tax, Order Resting Time, Order Cancellation Tax, Pro Rata Allocation

JEL Classification: G10

Suggested Citation

Ait-Sahalia, Yacine and Saglam, Mehmet, High Frequency Market Making: Implications for Liquidity (January 30, 2017). Available at SSRN: https://ssrn.com/abstract=2908438 or http://dx.doi.org/10.2139/ssrn.2908438

Yacine Ait-Sahalia (Contact Author)

Princeton University - Department of Economics ( email )

Fisher Hall
Princeton, NJ 08544
United States
609-258-4015 (Phone)
609-258-5398 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mehmet Saglam

University of Cincinnati - Department of Finance - Real Estate ( email )

Carl H. Lindner College of Business
Cincinnati, OH 45221
United States
(513) 556-9108 (Phone)

HOME PAGE: http://homepages.uc.edu/~saglammt/

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