What makes HFTs tick?

44 Pages Posted: 25 Jun 2019

See all articles by Alain Chaboud

Alain Chaboud

Federal Reserve Board - Division of International Finance

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 that two trading rule changes in the interdealer spot foreign exchange market, a reduction in the "tick size'' and a subsequent increase, had on the trading behavior of various types of market participants. We find that the most notable impact of the tick size reduction was 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 was linked to the richer information environment that arose after the tick size reduction and to the ability of faster traders to exploit it. Following the tick size decrease, and owing importantly to the increase in liquidity consumption by HFTs, the role of the spot market in price discovery dropped relative to that of the futures market. This points to the need for a balanced market ecology in financial markets where fast and slow traders coexist.

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? (June 21, 2019). Available at SSRN: https://ssrn.com/abstract=3407970 or http://dx.doi.org/10.2139/ssrn.3407970

Alain Chaboud

Federal Reserve Board - Division of International Finance ( email )

20th St. and Constitution Ave.
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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