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A dynamic limit order market with fast and slow traders

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  • Hoffmann, Peter

Abstract

This paper considers the role of high-frequency trading in a dynamic limit order market. Fast traders׳ ability to revise their quotes quickly after news arrivals helps to reduce the inefficiency that is rooted in the risk of being picked off, which increases trade. However, their presence induces slow traders to strategically submit limit orders with a lower execution probability, thereby reducing trade. Because speed is a source of market power, it enables fast traders to extract rents from other market participants and triggers a costly arms race that reduces social welfare. The model generates a number of testable implications concerning the effects of high-frequency trading in limit order markets.

Suggested Citation

  • Hoffmann, Peter, 2014. "A dynamic limit order market with fast and slow traders," Journal of Financial Economics, Elsevier, vol. 113(1), pages 156-169.
    • Handle: RePEc:eee:jfinec:v:113:y:2014:i:1:p:156-169
    DOI: 10.1016/j.jfineco.2014.04.002
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    References listed on IDEAS

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    More about this item

    Keywords

    High-frequency trading; Limit order market;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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