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High Frequency Trading and the New-Market Makers

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Author Info

  • Albert J. Menkveld

    (VU University Amsterdam)

Abstract

This paper links the recent fragmentation in equity trading to high frequency traders (HFTs). It shows how the success of a new market, Chi-X, critically depended on the participation of a large HFT who acts as a modern market-maker. The HFT, in turn, benefits from low fees in the entrant market, but also uses the incumbent market Euronext to offload nonzero positions. It trades, on average, 1397 times per stock per day in Dutch index stocks. The gross profit per trade is €O.88 which is the result of a €1.55 profit on the spread net of fees and a €O.68 'positioning' loss. This loss decomposes into a €0.45 profit on positions of less than five seconds, but a loss of €1.13 on longer duration positions. The realized maximum capital commit- ted due to margin requirements is €2.052 million per stock which implies an annualized Sharpe ratio of 9.35.

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File URL: http://papers.tinbergen.nl/11076.pdf
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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-076/2/DSF21.

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Date of creation: 10 May 2011
Date of revision: 15 Aug 2011
Handle: RePEc:dgr:uvatin:20110076

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Web page: http://www.tinbergen.nl

Related research

Keywords: high-frequency trading; market maker; multiple markets;

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References

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  1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
  2. Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, 02.
  3. Pagano, Marco, 1989. "Trading Volume and Asset Liquidity," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 255-74, May.
  4. Denis Gromb & Dimitri Vayanos, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," LSE Research Online Documents on Economics 448, London School of Economics and Political Science, LSE Library.
  5. Foucault, Thierry & Menkveld, Albert, 2006. "Competition for order flow and smart order routing systems," Les Cahiers de Recherche 831, HEC Paris.
  6. Hasabrouck, Joel & Sofianos, George, 1993. " The Trades of Market Makers: An Empirical Analysis of NYSE Specialists," Journal of Finance, American Finance Association, vol. 48(5), pages 1565-93, December.
  7. Foucault, Thierry & Kadan, Ohad & Kandel, Eugene, 2009. "Liquidity cycles and make/take fees in electronic markets," CEPR Discussion Papers 7551, C.E.P.R. Discussion Papers.
  8. S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
  9. Alain Chaboud & Benjamin Chiquoine & Erik Hjalmarsson & Clara Vega, 2009. "Rise of the machines: algorithmic trading in the foreign exchange market," International Finance Discussion Papers 980, Board of Governors of the Federal Reserve System (U.S.).
  10. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
  11. Menkveld, Albert J. & Koopman, Siem Jan & Lucas, Andre, 2007. "Modeling Around-the-Clock Price Discovery for Cross-Listed Stocks Using State Space Methods," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 213-225, April.
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Citations

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Cited by:
  1. Robert Litzenberger & Jeff Castura & Richard Gorelick, 2012. "The Impacts of Automation and High Frequency Trading on Market Quality," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 59-98, October.
  2. Bence Toth & Zoltan Eisler & Fabrizio Lillo & Julien Kockelkoren & Jean-Philippe Bouchaud & J. Doyne Farmer, 2011. "How does the market react to your order flow?," Papers 1104.0587, arXiv.org, revised May 2012.
  3. Bence Toth & Yves Lemperiere & Cyril Deremble & Joachim de Lataillade & Julien Kockelkoren & Jean-Philippe Bouchaud, 2011. "Anomalous price impact and the critical nature of liquidity in financial markets," Papers 1105.1694, arXiv.org, revised Nov 2011.
  4. Pawe{\l} Fiedor, 2013. "Frequency Effects on Predictability of Stock Returns," Papers 1310.5540, arXiv.org, revised Nov 2013.
  5. Fabien Guilbaud & Huyen Pham, 2011. "Optimal High Frequency Trading with limit and market orders," Working Papers hal-00603385, HAL.
  6. Nimalendran, Mahendrarajah & Ray, Sugata, 2014. "Informational linkages between dark and lit trading venues," Journal of Financial Markets, Elsevier, vol. 17(C), pages 230-261.
  7. Fabien Guilbaud & Huyen Pham, 2011. "Optimal High Frequency Trading with limit and market orders," Papers 1106.5040, arXiv.org.
  8. Sarah Draus & Mark van Achter, 2012. "Circuit Breakers and Market Runs," CSEF Working Papers 313, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  9. Kervel, V.L. van, 2013. "Competition between stock exchanges and optimal trading," Open Access publications from Tilburg University urn:nbn:nl:ui:12-5663709, Tilburg University.

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