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  3. 2021
  4. Preliminary Program
  5. Impact of Market Institutions on Information Content and Cost of Trading
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Impact of Market Institutions on Information Content and Cost of Trading

Paper Session

Sunday, Jan. 3, 2021 12:15 PM - 2:15 PM (EST)

Hosted By: American Finance Association
  • Chair: Torben Andersen, Northwestern University

Quantifying the High-Frequency Trading “Arms Race”: A Simple New Methodology and Estimates

Matteo Aquilina
,
Financial Conduct Authority
Eric Budish
,
University of Chicago
Peter O'Neill
,
Financial Conduct Authority

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 large portion of overall trading volume (about 20%). Race participation is concentrated, with the top-3 firms accounting for over half of all race wins and losses. Our main estimates suggest that eliminating latency arbitrage would reduce the cost of trading by 17% and that the total sums at stake are on the order of $5 billion annually in global equity markets.

Who Trades at the Close? Implications for Price Discovery, Liquidity, and Disagreement

Vincent Bogousslavsky
,
Boston College
Dmitriy Muravyev
,
Michigan State University

Abstract

We document the growing importance of the closing auction in the U.S. equity market and study its causes and implications. The closing auction accounts for a striking 7.5% of daily volume in 2018, up from 3.1% in 2010. The growth of indexing and ETFs shifts trading towards the close and distorts closing prices: they often deviate from closing quote midpoints, but the deviations revert by half shortly after the close and fully overnight. As volume migrates towards the close, liquidity at the open deteriorates. Finally, we introduce a novel measure of investor disagreement, the ratio of auction-to-total volume, and show that higher disagreement positively predicts future stock returns.

The Information in Industry-Neutral Self-Financed Trades

Yashar Barardehi
,
Chapman University
Zhi Da
,
University of Notre Dame
Mitch Warachka
,
Chapman University

Abstract

We identify Industry-Neutral Self-Financed Informed Trading (INSFIT) by long only fund managers who possess a positive short-lived private signal and self finance informed stock purchases by selling an equivalent dollar amount of stock in the same industry. INSFIT, which constitutes less than 1% of trading, produces a cumulative abnormal return spread of nearly 0.90% over the subsequent ten days. INSFIT also precedes the release of positive public information. The prevalence of relative valuation as well as the need to maintain industry allocations and hedge industry exposure motivate INSFIT’s industry neutrality. Furthermore, INSFIT occurs more frequently among cash-constrained managers but is uncorrelated across fund managers. Although INSFIT involves relatively large dollar-denominated trades, transaction costs cannot account for its profitability.

Who Uses Which Order Type and Why?

Sida Li
,
University of Illinois-Urbana-Champaign
Mao Ye
,
University of Illinois-Urbana-Champaign
Miles Zheng
,
University of Illinois-Urbana-Champaign

Abstract

Clientele effects explain the proliferation of order types on U.S. stock exchanges. Market and plain limit orders lose money, indicating that informed traders use more complex orders. The most complex order types refuse to trade with the national best bid and offer (NBBO) if the NBBO appears on another exchange. Fees provide one explanation for non-routable orders because Reg NMS might route orders to worse prices after adjusting for routing fees. Non-routable orders also win speed races to capture quick profits and contain short-term information. However, all order types containing long-term information are routable and often tailored to corporate events.
Discussant(s)
Albert Kyle
,
University of Maryland
Dermot Murphy
,
University of Illinois-Chicago
Vyacheslav Fos
,
Boston College
Chester Spatt
,
Carnegie Mellon University
JEL Classifications
  • G1 - Asset Markets and Pricing