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Automated Liquidity Provision and the Demise of Traditional Market Making

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  • Austin Gerig
  • David Michayluk

Abstract

Traditional market makers are losing their importance as automated systems have largely assumed the role of liquidity provision in markets. We update the model of Glosten and Milgrom (1985) to analyze this new world: we add multiple securities and introduce an automated market maker who uses the relationships between securities to price order flow. This new automated participant transacts the majority of orders, sets prices that are more efficient, and increases informed and decreases uninformed traders' transaction costs. These results can explain the recent dominance of high frequency trading in US markets and the corresponding increase in trading volume and decrease in transaction costs for US stocks.

Suggested Citation

  • Austin Gerig & David Michayluk, 2010. "Automated Liquidity Provision and the Demise of Traditional Market Making," Papers 1007.2352, arXiv.org.
    • Handle: RePEc:arx:papers:1007.2352
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    Cited by:

    1. Hasbrouck, Joel & Saar, Gideon, 2013. "Low-latency trading," Journal of Financial Markets, Elsevier, vol. 16(4), pages 646-679.
    2. Austin Gerig, 2012. "High-Frequency Trading Synchronizes Prices in Financial Markets," Papers 1211.1919, arXiv.org.
    3. Kun Li, 2018. "Do high-frequency fleeting orders exacerbate market illiquidity?," Electronic Commerce Research, Springer, vol. 18(2), pages 241-255, June.
    4. Ya‐Kai Chang & Robin K. Chou, 2022. "Algorithmic trading and market quality: Evidence from the Taiwan index futures market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(10), pages 1837-1855, October.
    5. Hee Su Roh & Yinyu Ye, 2015. "Market Making with Model Uncertainty," Papers 1509.07155, arXiv.org, revised Nov 2015.
    6. Eun Jung Lee, 2015. "High Frequency Trading in the Korean Index Futures Market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(1), pages 31-51, January.
    7. Bellia, Mario & Pelizzon, Loriana & Subrahmanyam, Marti & Uno, Jun & Yuferova, Darya, 2017. "Coming early to the party," SAFE Working Paper Series 182, Leibniz Institute for Financial Research SAFE.
      • Mario Bellia & Loriana Pelizzon & Marti G. Subrahmanyam & Jun Uno & Darya Yuferova, 2020. "Coming early to the party," Working Papers 2020:11, Department of Economics, University of Venice "Ca' Foscari".
    8. 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.
    9. Benjamin Myers & Austin Gerig, 2013. "Simulating the Synchronizing Behavior of High-Frequency Trading in Multiple Markets," Papers 1311.4160, arXiv.org.
    10. Kin‐Yip Ho & Wai‐Man Liu & Jing Yu, 2018. "Public News Arrival and Cross‐Asset Correlation Breakdown," International Review of Finance, International Review of Finance Ltd., vol. 18(3), pages 411-451, September.

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    More about this item

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G19 - Financial Economics - - General Financial Markets - - - Other

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