Missing Best Price in Lightning-Fast Markets

Abstract

I develop a model to study the frequency of trade-throughs, i.e., an order is executed at an inferior price than the best price quoted on other exchanges, by explicitly modeling exchanges' order-processing speeds and the connection speeds between exchanges. I find that trade-through frequency can increase when all exchanges speed up order processing. In contrast, increasing connection speeds between exchanges can significantly reduce trade-through rates. I further show that exchanges seem only to have incentives to compete on the "wrong" speed-order-processing speeds, not connection speeds.

Keywords: Exchange Speed, High-Frequency Trading, Order Protection Rule, Market Fragmentation, Trade-Through