On the Effects of Continuous Trading
57 Pages Posted: 1 Dec 2020 Last revised: 22 Jun 2022
Date Written: October 7, 2020
The continuous limit order book is a prominent design feature of modern securities markets. Theoretical literature suggests that this feature has an undesirable side effect; it enables latency arbitrage, which generates adverse selection and drives up liquidity costs. As a superior alternative, the literature recommends switching to frequent batch auctions. We examine an opposite move, whereby a large modern market switches from auctions to continuous trading. Consistent with theory, adverse selection and trading costs increase significantly. Some non-arbitrage volume is lost, but the gain in arbitrage volume is greater, benefiting exchange revenue. The latter result helps explain the current dominance of the continuous design.
Keywords: liquidity, adverse selection, continuous trading, batch auctions
JEL Classification: G14, G15
Suggested Citation: Suggested Citation