Trading Speed, Market Liquidity, and Welfare
Paper Session
Sunday, Jan. 8, 2017 3:15 PM – 5:15 PM
Swissotel Chicago, Zurich B
- Chair: Wei Xiong, Princeton University
Need for Speed? Exchange Latency and Liquidity
Abstract
Speeding up the exchange does not necessarily improve liquidity. On the one hand, more speed enables a high-frequency market maker (HFM) to update his quotes faster on incoming news. This reduces his payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet speculative high-frequency bandits, thus less likely to meet liquidity traders. This raises the spread. The net effect depends on a security’s news-to-liquidity-trader ratio.High Frequency Market Making
Abstract
We propose an inventory-based model of market making where a strategic high frequency trader exploits his speed and informational advantages to place quotes that interact with low frequency traders. We characterize the optimal market making policy analytically, illustrate that it generates endogenous order cancellations, and compute the long-run equilibrium bid-ask spread and other liquidity measures. The model predicts that the high frequency trader provides more liquidity as he gets faster and shies away from it as volatility increases due to a higher risk of his stale quotes being picked by arbitrageurs. Competition with another liquidity provider increases the overall liquidity. Finally, we provide the first formal, model-based analysis of the impact of four widely discussed policies designed to regulate high frequency trading: imposing a transactions tax, setting minimum-time limits before quotes can be cancelled, taxing the cancellations of limit orders, and replacing time priority with a pro rata or random allocation. We find that these policies are largely unable to induce high frequency traders to provide robust liquidity.Liquidity Provision Under Stress: The Fast, the Slow, and the Dead
Abstract
We investigate the reliability and the consistency of liquidity provision by fast liquidity providers (“FLPs”) in periods of market stress. We draw on a comprehensive, non-public, account-level intraday dataset of trading activity in crude oil futures (the world’s largest commodity market), where liquidity provision has always been entirely voluntary. That market was transformed in 2006 by the onset of electronic trading, with liquidity provision since dominated by machines trading at ultra-high speeds. We ask if these FLPs significantly reduce their participation or liquidity provision amid liquidity shocks or in information-rich periods (characterized by persistently high volatility or elevated information asymmetry). Using market stress episodes from January 2006 to June 2009, we compare FLPs’ trading with the contemporaneous behaviors of the (now “Dead”) Locals in the trading pits and of the (“Slow”) e-Locals in the electronic market. Compared to slower liquidity providers, we find that FLPs withdraw more (and provide less liquidity to customers) during high-volatility and other information-rich periods but are less sensitive to liquidity shocks. In contrast, FLP-to-customer spreads are not substantially affected by high volatility per se but go up significantly in response to high informational asymmetries.Discussant(s)
Thierry Foucault
, HEC Paris
Adam D. Clark-Joseph
, University of Illinois-Urbana-Champaign
Duane Seppi
, Carnegie Mellon University
Sophie Moinas
, University of Toulouse
JEL Classifications
- G1 - Asset Markets and Pricing
- G2 - Financial Institutions and Services