Order Flow Segmentation, Liquidity and Price Discovery: The Role of Latency Delays
41 Pages Posted: 24 Jul 2017
Date Written: July 19, 2017
Latency delays – known as "speed bumps" – are an intentional slowing of order flow by exchanges. Supporters contend that delays protect market makers from high-frequency arbitrage, while opponents warn that delays promote "quote fading" by market makers. We construct a model of informed trading in a fragmented market, where one market operates a conventional order book, and the other imposes a latency delay on market orders. We show that informed investors migrate to the conventional exchange, widening the quoted spread; the quoted spread narrows at the delayed exchange. The overall market quality impact depends on the nature of the delay: short latency delays lead to improved trading costs for liquidity investors, but worsening price discovery; sufficiently long delays improve both.
Keywords: Latency delays, speed bumps, market fragmentation
JEL Classification: G14, G18
Suggested Citation: Suggested Citation