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Front-Running and Market Quality: An Evolutionary Perspective on High Frequency Trading

23 Pages Posted: 23 Mar 2017 Last revised: 12 Sep 2017

Thorsten Hens

University of Zurich - Department of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute (Zurich Center)

Terje Lensberg

Norwegian School of Economics (NHH) - Department of Finance

Klaus Reiner Schenk-Hoppé

University of Manchester - Department of Economics; Norwegian School of Economics (NHH) - Department of Finance

Date Written: March 7, 2017

Abstract

We study front-running by high frequency traders (HFTs) in a limit order model with continuous trading. The model describes an evolutionary equilibrium of low frequency traders (LFTs) who compete in portfolio management services by offering investment styles. The introduction of front-runners inflicts heavy losses on speculators, while leaving passive investors relatively unscathed. This encourages investment in the market portfolio and markedly reduces overall turnover. Speculative trading persists despite its lower profitability. By most measures, market quality is not affected to any significant extent by front-running HFTs.

Keywords: Front running; HFT; market quality

Suggested Citation

Hens, Thorsten and Lensberg, Terje and Schenk-Hoppé, Klaus Reiner, Front-Running and Market Quality: An Evolutionary Perspective on High Frequency Trading (March 7, 2017). Swiss Finance Institute Research Paper No. 17-10. Available at SSRN: https://ssrn.com/abstract=2930844 or http://dx.doi.org/10.2139/ssrn.2930844

Thorsten Hens (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 32
Zurich, 8032
Switzerland
+41-44 634 37 06 (Phone)

Norwegian School of Economics and Business Administration (NHH)

Helleveien 30
Bergen, 5045
Norway

Swiss Finance Institute (Zurich Center)

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Terje Lensberg

Norwegian School of Economics (NHH) - Department of Finance ( email )

Helleveien 30
Bergen, N-5045
Norway
+47 5595 9206 (Phone)

Klaus Schenk-Hoppé

University of Manchester - Department of Economics ( email )

Arthur Lewis Building
Oxford Road
Manchester, M13 9PL
United Kingdom

Norwegian School of Economics (NHH) - Department of Finance ( email )

Helleveien 30
N-5045 Bergen
Norway

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