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HFT and Market Quality

Author

Listed:
  • Bruno Biais

    (Toulouse School of Economics (CRM/CNRS) - Chaire FBF/IDEI)

  • Thierry Foucault

    (HEC)

Abstract

We discuss the economics of high-frequency trading (hereafter HFT), survey empirical findings and offer policy recommendations. HFT involves high speed connections to exchanges, computerized trading, and very short-term positions. Beyond these common features, HFT strategies are heterogeneous. They can involve market-making, directional trade, arbitrage, and possibly manipulation. The empirical literature finds that HFT market-making is profitable only because of favorable exchange fees. HFT market orders predict future short-term market movements and correspondingly earn profits, at the expense of other market participants. Yet, there is no empirical evidence of adverse effects of HFT on liquidity. HFT could generate negative externalities, by inducing adverse selection for slower traders, or enhancing the risk of trading firms’ failure waves. To cope with these problems, slow-traders’ friendly market mechanisms should be available, and minimum capital requirements and stress tests should be implemented.

Suggested Citation

  • Bruno Biais & Thierry Foucault, 2014. "HFT and Market Quality," Bankers, Markets & Investors, ESKA Publishing, issue 128, pages 5-19, January-F.
    • Handle: RePEc:rbq:journl:i:128:p:5-19
    as

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    References listed on IDEAS

    as
    1. Thierry Foucault & Ailsa Röell & Patrik Sandås, 2003. "Market Making with Costly Monitoring: An Analysis of the SOES Controversy," The Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 345-384.
    2. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2013. "Liquidity Cycles and Make/Take Fees in Electronic Markets," Journal of Finance, American Finance Association, vol. 68(1), pages 299-341, February.
    3. Albert J. Menkveld & Boyan Jovanovic, 2010. "Middlemen in Limit Order Markets," 2010 Meeting Papers 955, Society for Economic Dynamics.
    4. Copeland, Thomas E & Galai, Dan, 1983. "Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-1469, December.
    5. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    6. Terrence Hendershott & Ryan Riordan, 2009. "Algorithmic Trading and Information," Working Papers 09-08, NET Institute, revised Aug 2009.
    7. Jean-Edouard Colliard & Thierry Foucault, 2012. "Trading Fees and Efficiency in Limit Order Markets," The Review of Financial Studies, Society for Financial Studies, vol. 25(11), pages 3389-3421.
    8. Sandas, Patrik, 2001. "Adverse Selection and Competitive Market Making: Empirical Evidence from a Limit Order Market," The Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 705-734.
    9. Jean-Edouard Colliard & Thierry Foucault, 2012. "Trading Fees and Efficiency in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 25(11), pages 3389-3421.
    10. Giovanni Cespa & Thierry Foucault, 2014. "Sale of Price Information by Exchanges: Does It Promote Price Discovery?," Management Science, INFORMS, vol. 60(1), pages 148-165, January.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    High Frequency Trading; Algorithmic Trading; Liquidity; Price Discovery;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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