The Cost of Routing Orders to High Frequency Traders
62 Pages Posted: 8 Nov 2018
Date Written: June 8, 2018
Institutional brokers and high-frequency liquidity providers (HFLPs) engage in trading relationships that involve monetary incentives for brokers if they route their clients' orders to HFLPs. This paper examines whether the institutional clients benefit from these routing relationships. We analyze a novel dataset of institutional large-orders whose child-orders can be routed to the HFLPs with investor's consent and find that orders that are routed to HFLPs realize substantially higher trading costs. We obtain causal evidence by utilizing the trades of investors who oppose HFLP routing. The cost increase is due to early information leakage about the investor's liquidity need.
Keywords: High-Frequency Trading, Transaction Costs, Smart Routing
JEL Classification: G12, G14
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