What makes HFTs tick? Tick size changes and information advantage in a market with fast and slow traders

49 Pages Posted: 25 Jun 2019 Last revised: 6 Oct 2022

See all articles by Alain Chaboud

Alain Chaboud

Board of Governors of the Federal Reserve System

Avery Dao

Columbia University, Graduate School of Arts and Sciences, Department of Economics, Students

Clara Vega

Board of Governors of the Federal Reserve System

Date Written: June 21, 2019

Abstract

We study the impact of two changes in the `"tick size," a reduction and a subsequent increase, on the trading behavior of fast and slow traders in the spot foreign exchange market. We find that the most notable impact of the tick size reduction is a substantial increase in the liquidity demand of high-frequency traders (HFTs), not the decrease in their liquidity provision predicted by recent literature. We show that this change in behavior is linked to the richer information environment that arises with the smaller tick size and to the ability of fast traders to profit from it, often at the detriment of slower traders. Following the tick size decrease and the increase in liquidity demand by HFTs in the spot market, the role of the spot market in price discovery drops relative to that of the futures market. We discuss these findings in the context of the impact of HFTs on the information content of financial markets.

Keywords: High Frequency Trading, tick size, minimum price variation, market liquidity, price discovery, foreign exchange

JEL Classification: F3, G12, G14, G15

Suggested Citation

Chaboud, Alain and Dao, Avery and Vega, Clara, What makes HFTs tick? Tick size changes and information advantage in a market with fast and slow traders (June 21, 2019). Available at SSRN: https://ssrn.com/abstract=3407970 or http://dx.doi.org/10.2139/ssrn.3407970

Alain Chaboud

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
(202) 452 3756 (Phone)

Avery Dao

Columbia University, Graduate School of Arts and Sciences, Department of Economics, Students ( email )

New York, NY
United States

Clara Vega (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/research/staff/vegaclarax.htm

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