Strategic Speed Choice by High-Frequency Traders Under Speed Bumps

42 Pages Posted: 5 Nov 2018

See all articles by Jun Aoyagi

Jun Aoyagi

University of California, Berkeley - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: November 4, 2018

Abstract

We study how high-frequency traders (HFTs) strategically decide their speed level in a market with a random speed bump. If HFTs recognize the market impact of their speed decision, they perceive a wider bid-ask spread as an endogenous upward-sloping cost of being faster. We find that the speed elasticity of the bid-ask spread (slope of the endogenous cost function) negatively depends on the expected length of a speed bump since a longer delay makes market makers insensitive to HFTs' speed increment. Hence, speed bumps promote the investment of HFTs in high-speed technology by reducing the marginal cost of getting faster, undermining their intended purpose of protecting market makers. Depending on the expected length of a bump, an arms race among HFTs exhibits both complementarity and substitution. These findings explain the ambiguous empirical results regarding speed bumps and adverse selection for market makers.

Keywords: High-frequency trading, market structure, speed bumps, adverse selection, strategic speed decision

JEL Classification: D40, D47, G10, G18, G20

Suggested Citation

Aoyagi, Jun, Strategic Speed Choice by High-Frequency Traders Under Speed Bumps (November 4, 2018). Available at SSRN: https://ssrn.com/abstract=3278043 or http://dx.doi.org/10.2139/ssrn.3278043

Jun Aoyagi (Contact Author)

University of California, Berkeley - Department of Economics ( email )

CA
United States

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