High-Frequency Trading, Endogenous Capital Commitment and Market Quality
84 Pages Posted: 25 Oct 2019
Date Written: October 9, 2019
I study market quality implications of the competition between traditional market making and high-frequency trading. A long-run traditional market maker responds to the competition from high-frequency traders by reducing both the spread and the amount of capital committed in market making. While a lower spread is beneficial, less capital commitment deteriorates market quality. Specifically, the market's capacity to satisfy large demand is impaired. My model integrates price and quantity effects of high-frequency trading to better characterize its implications for market quality. I argue that focusing on spread alone is not always effective in measuring market quality. I further use this framework to analyze market quality implications of different high-frequency trading regulatory measures.
Keywords: High-Frequency Trading, Market Quality
JEL Classification: G14
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