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High frequency trading and price discovery

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  • Brogaard, Jonathan
  • Hendershott, Terrence
  • Riordan, Ryan
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    Abstract

    We examine empirically the role of high-frequency traders (HFTs) in price discovery and price efficiency. Based on our methodology, we find overall that HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances. JEL Classification: G12

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 1602.

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    Date of creation: Nov 2013
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    Handle: RePEc:ecb:ecbwps:20131602

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    Keywords: high frequency trading; price discovery; price formation; pricing errors;

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    1. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers, Duke University, Department of Economics 02-16, Duke University, Department of Economics.
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    Cited by:
    1. Marouane Anane & Frédéric Abergel, 2014. "Optimal high frequency strategy in an omniscient order book," Working Papers hal-01006401, HAL.
    2. Carrion, Allen, 2013. "Very fast money: High-frequency trading on the NASDAQ," Journal of Financial Markets, Elsevier, Elsevier, vol. 16(4), pages 680-711.
    3. Aitken, Michael & Cumming, Douglas & Zhan, Feng, 2013. "High frequency trading and end-of-day price dislocation," CFS Working Paper Series 2013/16, Center for Financial Studies (CFS).
    4. Rene Carmona & Kevin Webster, 2013. "The Self-Financing Equation in High Frequency Markets," Papers 1312.2302, arXiv.org.
    5. Jonathan Brogaard & Corey Garriott & Anna Pomeranets, 2014. "High-Frequency Trading Competition," Working Papers 14-19, Bank of Canada.

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