Quantifying the High-Frequency Trading "Arms Race"

57 Pages Posted: 26 Jun 2020 Last revised: 15 Jul 2021

See all articles by Matteo Aquilina

Matteo Aquilina

Bank for International Settlements (BIS) - Financial Stability Board (FSB)

Eric B. Budish

University of Chicago - Booth School of Business

Peter O'Neill

Financial Conduct Authority

Date Written: July 2021

Abstract

We use stock exchange message data to quantify the negative aspect of high-frequency trading,
known as “latency arbitrage.” The key difference between message data and widely-familiar limit
order book data is that message data contain attempts to trade or cancel that fail. This allows the
researcher to observe both winners and losers in a race, whereas in limit order book data you
cannot see the losers, so you cannot directly see the races. We find that latency-arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5-10 millionths of a second), and account for a remarkably large portion of overall
trading volume (about 20%). Race participation is concentrated, with the top 6 firms accounting
for over 80% of all race wins and losses. The average race is worth just a small amount (about
half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest
that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market's cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

Suggested Citation

Aquilina, Matteo and Budish, Eric B. and O'Neill, Peter, Quantifying the High-Frequency Trading "Arms Race" (July 2021). Chicago Booth Research Paper No. 20-16, Chicago Booth: George J. Stigler Center for the Study of the Economy & the State Working Paper No. 45, Fama-Miller Working Paper Series, Initiative on Global Markets Paper No. 173, University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-86, Available at SSRN: https://ssrn.com/abstract=3636323 or http://dx.doi.org/10.2139/ssrn.3636323

Matteo Aquilina

Bank for International Settlements (BIS) - Financial Stability Board (FSB) ( email )

Basel
Switzerland

Eric B. Budish (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-8453 (Phone)

Peter O'Neill

Financial Conduct Authority ( email )

25 The North Colonnade
Canary Wharf
London, E14 5HS
United Kingdom

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