High-Frequency Market Making: Liquidity Provision, Adverse Selection, and Competition
70 Pages Posted: 22 Nov 2017 Last revised: 5 Jun 2018
Date Written: November 15, 2017
Using data from the NYSE Euronext Paris, with a specific identifier for electronic market- making activity, I examine the role of designated liquidity providers played by high-frequency traders (HFTs) as introduced by the forthcoming MiFID II regulation. I find that HFTs do provide liquidity to the market, but strategically so, to avoid being adversely selected by other fast traders when providing liquidity to them. Conversely, when they provide liquidity to slow traders, there is no evidence of adverse selection. I exploit a change in the liquidity provision agreement that introduces more competition among market makers. I show that higher competition is beneficial for the market. Liquidity provision increases and the quoted bid-ask spread decreases, as well as the adverse selection costs faced by all traders, especially for slow traders.
Keywords: HFT, Market Makers, Liquidity Provision, Adverse Selection, Competition
JEL Classification: G12, G14
Suggested Citation: Suggested Citation