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Need for Speed? Exchange Latency and Liquidity

Author

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  • Albert J. Menkveld
  • Marius A. Zoican

Abstract

A faster exchange does not necessarily improve liquidity. On the one hand, speed enables a high-frequency market maker (HFM) to update quotes faster on incoming news. This reduces payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet speculative high-frequency bandits, and thus are less likely to meet liquidity traders. This raises the spread. The net effect of exchange speed depends on a security’s news-to-liquidity-trader ratio.

Suggested Citation

  • Albert J. Menkveld & Marius A. Zoican, 2017. "Need for Speed? Exchange Latency and Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1188-1228.
  • Handle: RePEc:oup:rfinst:v:30:y:2017:i:4:p:1188-1228.
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2017. "High frequency trading and the 2008 short-sale ban," Journal of Financial Economics, Elsevier, vol. 124(1), pages 22-42.
    2. Oliver Linton & Soheil Mahmoodzadeh, 2018. "Implications of high-frequency trading for security markets," CeMMAP working papers CWP06/18, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
    3. repec:eee:finmar:v:37:y:2018:i:c:p:1-16 is not listed on IDEAS
    4. Friederich, Sylvain & Payne, Richard, 2015. "Order-to-trade ratios and market liquidity," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 214-223.
    5. repec:spr:annopr:v:260:y:2018:i:1:d:10.1007_s10479-016-2286-1 is not listed on IDEAS
    6. Linton, O. & Mahmoodzadeh, S., 2018. "Implications of High-Frequency Trading for Security Markets," Cambridge Working Papers in Economics 1802, Faculty of Economics, University of Cambridge.
    7. Thierry Foucault & Roman Kozhan & Wing Wah Tham, 2017. "Toxic Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1053-1094.
    8. Xuefeng Gao & Yunhan Wang, 2018. "Electronic Market Making and Latency," Papers 1806.05849, arXiv.org.
    9. Foucault, Thierry & Moinas, Sophie, 2018. "Is Trading Fast Dangerous?," TSE Working Papers 18-881, Toulouse School of Economics (TSE).
    10. Aldrich, Eric M. & Friedman, Daniel, 2017. "Order protection through delayed messaging," Discussion Papers, Research Professorship Market Design: Theory and Pragmatics SP II 2017-502, Social Science Research Center Berlin (WZB).
    11. repec:eee:empfin:v:43:y:2017:i:c:p:74-90 is not listed on IDEAS
    12. Alasdair Brown & Fuyu Yang, 2015. "Adverse Selection, Speed Bumps and Asset Market Quality," University of East Anglia Applied and Financial Economics Working Paper Series 070, School of Economics, University of East Anglia, Norwich, UK..
    13. Declerck, F., 2016. "High-frequency trading, geographical concerns and the curvature of the Earth," Financial Stability Review, Banque de France, issue 20, pages 153-160, April.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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