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Front-Running and Market Quality: An Evolutionary Perspective on High Frequency Trading

Author

Listed:
  • Thorsten Hens

    (University of Zurich, Norwegian School of Economics and Business Administration (NHH), and Swiss Finance Institute)

  • Terje Lensberg

    (Norwegian School of Economics (NHH))

  • Klaus Reiner Schenk-Hoppé

    (University of Manchester and Norwegian School of Economics (NHH))

Abstract

We study front-running by high frequency traders (HFTs) in a limit order model with continuous trading. The model describes an evolutionary equilibrium of low frequency traders (LFTs) who compete in portfolio management services by offering investment styles. The introduction of front-runners inflicts heavy losses on speculators, while leaving passive investors relatively unscathed. This encourages investment in the market portfolio and markedly reduces overall turnover. Speculative trading persists despite its lower profitability. By most measures, market quality is not affected to any significant extent by front-running HFTs.

Suggested Citation

  • Thorsten Hens & Terje Lensberg & Klaus Reiner Schenk-Hoppé, 2017. "Front-Running and Market Quality: An Evolutionary Perspective on High Frequency Trading," Swiss Finance Institute Research Paper Series 17-10, Swiss Finance Institute, revised Sep 2017.
    • Handle: RePEc:chf:rpseri:rp1710
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    Cited by:

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    2. Aït-Sahalia, Yacine & Brunetti, Celso, 2020. "High frequency traders and the price process," Journal of Econometrics, Elsevier, vol. 217(1), pages 20-45.
    3. Ziyi Xu & Xue Cheng, 2022. "Are Large Traders Harmed by Front-running HFTs?," Papers 2211.06046, arXiv.org, revised Jul 2023.

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