Liquid speed: A congestion fee for low-latency exchanges
European Finance Association 2020 Helsinki
38 Pages Posted: 26 Jul 2019 Last revised: 22 May 2020
Date Written: May 22, 2020
Trading activity surges associated with latency arbitrage are costly, as they lead to both lower liquidity and inefficient investments in order processing capacity that remains idle 90% of the time. A congestion message fee on liquidity-taking orders alleviates both concerns. The fee surges during activity bursts, as high-frequency traders (HFTs) simultaneously race to market. A higher fee limits burst intensity, which reduces adverse selection and narrows spreads. Exchanges have strong incentives to replace co-location subscriptions with congestion fees to extract higher revenues from HFTs. A calibration exercise suggests a minimum congestion fee between 15-35% of the average latency arbitrage opportunity.
Keywords: high-frequency trading, trade surges, congestion pricing, market design
JEL Classification: G10, G14, G23
Suggested Citation: Suggested Citation