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High Frequency Traders: Taking Advantage of Speed

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  • Yacine Aït-Sahalia
  • Mehmet Saglam

Abstract

We propose a model of dynamic trading where a strategic high frequency trader receives an imperfect signal about future order flows, and exploits his speed advantage to optimize his quoting policy. We determine the provision of liquidity, order cancellations, and impact on low frequency traders as a function of both the high frequency trader's latency, and the market volatility. The model predicts that volatility leads high frequency traders to reduce their provision of liquidity. Finally, we analyze the impact of various policies designed to potentially regulate high frequency trading.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19531.

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Date of creation: Oct 2013
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Handle: RePEc:nbr:nberwo:19531

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  1. 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.
  2. Albert J. Menkveld & Boyan Jovanovic, 2010. "Middlemen in Limit Order Markets," 2010 Meeting Papers 955, Society for Economic Dynamics.
  3. Hendershott, Terrence & Jones, Charles M. & Menkveld, Albert J., 2008. "Does algorithmic trading improve liquidity?," CFS Working Paper Series 2008/41, Center for Financial Studies (CFS).
  4. Robert A. Jarrow & Philip Protter, 2012. "A Dysfunctional Role Of High Frequency Trading In Electronic Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(03), pages 1250022-1-1.
  5. Emiliano Pagnotta & Thomas Philippon, 2011. "Competing on Speed," NBER Working Papers 17652, National Bureau of Economic Research, Inc.
  6. Cespa, Giovanni & Foucault, Thierry, 2008. "Insiders-Outsiders, Transparency and the Value of the Ticker," CEPR Discussion Papers 6794, C.E.P.R. Discussion Papers.
  7. Hasbrouck, Joel & Saar, Gideon, 2009. "Technology and liquidity provision: The blurring of traditional definitions," Journal of Financial Markets, Elsevier, vol. 12(2), pages 143-172, May.
  8. Menkveld, Albert J., 2013. "High frequency trading and the new market makers," Journal of Financial Markets, Elsevier, vol. 16(4), pages 712-740.
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