Does High Frequency Market Manipulation Harm Market Quality?

Abstract

Manipulation of financial markets has long been a concern. With the automation of financial markets, the potential for high frequency market manipulation has arisen. Yet, such behavior is hidden within vast sums of order book data, making it difficult to define and to detect. We develop a tangible definition of one type of manipulation, spoofing. Using proprietary user-level identified order book data, we show the determinants of spoofing. Exploiting SEC Litigation Releases that exogenously reduce spoofing, we show causal evidence that spoofing increases return volatility, increases trading costs, and decreases price efficiency. The findings indicate that spoofing harms liquidity and price discovery.

Keywords: high-frequency trading, market quality, market manipulation

JEL Classification: G10, G12, G14