High Frequency Trading and Fragility

48 Pages Posted: 17 May 2017  

Giovanni Cespa

Cass Business School; Centre for Economic Policy Research (CEPR)

Xavier Vives

University of Navarra - IESE Business School; Universitat Pompeu Fabra (UPF); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Multiple version iconThere are 4 versions of this paper

Date Written: November 2016

Abstract

We show that limited dealer participation in the market, coupled with an informational friction resulting from high frequency trading, can induce demand for liquidity to be upward sloping and strategic complementarities in traders' liquidity consumption decisions: traders demand more liquidity when the market becomes less liquid, which in turn makes the market more illiquid, fostering the initial demand hike. This can generate market instability, where an initial dearth of liquidity degenerates into a liquidity rout (as in a flash crash). While in a transparent market, liquidity is increasing in the proportion of high frequency traders, in an opaque market strategic complementarities can make liquidity U-shaped in this proportion as well as in the degree of transparency.

Keywords: market fragmentation; high frequency trading; flash crash; asymmetric information

JEL Classification: G10, G12, G14

Suggested Citation

Cespa, Giovanni and Vives, Xavier, High Frequency Trading and Fragility (November 2016). IESE Business School Working Paper No. 1161-E. Available at SSRN: https://ssrn.com/abstract=2969739 or http://dx.doi.org/10.2139/ssrn.2969739

Giovanni Cespa

Cass Business School ( email )

106, Bunhill Row
London, EC1Y 8TZ
Great Britain
+44(0)2040708704 (Phone)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Xavier Vives (Contact Author)

University of Navarra - IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

HOME PAGE: http://wwwapp.iese.edu/faculty/facultyDetail.asp?lang=en&prof=xv

Universitat Pompeu Fabra (UPF) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Paper statistics

Downloads
28
Abstract Views
420