Who Provides Liquidity, and When?

65 Pages Posted: 26 Jun 2019 Last revised: 19 Jun 2023

See all articles by Sida Li

Sida Li

Brandeis University

Xin Wang

Nanyang Technological University (NTU) - Division of Banking & Finance

Mao Ye

University of Illinois at Urbana-Champaign

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Date Written: June 2019

Abstract

We model competition for liquidity provision between high-frequency traders (HFTs) and slower execution algorithms designed to minimize transaction costs for buy-side institutions (B-Algos). Under continuous pricing, B-Algos dominate liquidity provision by using aggressive limit orders to stimulate HFTs’ market orders. Under discrete pricing, HFTs dominate liquidity provision if the bid–ask spread is binding at one tick. If the tick size is not binding, B-Algos choose between stimulating HFTs and providing liquidity to other non-HFTs. Flash crashes arise under certain parameter values. Transaction costs can be negatively correlated with the bid–ask spread when all traders can provide liquidity.

Suggested Citation

Li, Sida and Wang, Xin and Ye, Mao, Who Provides Liquidity, and When? (June 2019). NBER Working Paper No. w25972, Available at SSRN: https://ssrn.com/abstract=3408904

Sida Li (Contact Author)

Brandeis University ( email )

Waltham, MA 02454
United States
2153509449 (Phone)

Xin Wang

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-B1B-76 Nanyang Avenue
Singapore, 639798
Singapore
+6593816646 (Phone)

HOME PAGE: http://https://www.financexinwang.com/

Mao Ye

University of Illinois at Urbana-Champaign ( email )

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