Human vs. High-Frequency Traders, Penny Jumping, and Tick Size

34 Pages Posted: 9 Dec 2017

See all articles by Soheil Mahmoodzadeh

Soheil Mahmoodzadeh

University of Cambridge - Faculty of Economics

Ramazan Gencay

Simon Fraser University

Date Written: July 24, 2017

Abstract

This paper examines changes in market quality resulting from the smaller tick size of the interbank foreign exchange market. Coupled with the lower tick size, the special composition of traders and their order placement strategies created a suitable environment for high- frequency traders (HFT’s) to implement sub-penny jumping strategy to front-run human traders. We show that the spread declined following the introduction of decimal pip pricing. However, benefits of spread reduction were mostly absorbed by the HFT’s. Market depths were also significantly reduced with the occupation of the top of the order book by HFT’s. This new environment changed the market maker-market taker composition between different traders and altered price impacts of the order flows.

Keywords: Interbank Foreign Exchange Market, Tick Size, Market Quality

JEL Classification: F31, G14, G15

Suggested Citation

Mahmoodzadeh, Soheil and Gencay, Ramazan, Human vs. High-Frequency Traders, Penny Jumping, and Tick Size (July 24, 2017). Journal of Banking and Finance, Vol. 85, 2017. Available at SSRN: https://ssrn.com/abstract=3082682

Soheil Mahmoodzadeh (Contact Author)

University of Cambridge - Faculty of Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

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