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Order-Flow Segmentation, Liquidity, and Price Discovery: The Role of Latency Delays

Published online by Cambridge University Press:  13 May 2020

Michael Brolley Open the ORCID record for Michael Brolley [Opens in a new window]  and
David A. Cimon Open the ORCID record for David A. Cimon [Opens in a new window]
Michael Brolley*
Affiliation:
Brolley, mbrolley@wlu.ca, Wilfrid Laurier University
David A. Cimon
Affiliation:
Cimon, dcimon@wlu.ca, Wilfrid Laurier University
*
Brolley (corresponding author), mbrolley@wlu.ca
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Abstract

Latency delays intentionally slow order execution at an exchange, often to protect market makers against latency arbitrage. We study informed trading in a fragmented market in which one exchange introduces a latency delay on market orders. Liquidity improves at the delayed exchange as informed investors emigrate to the conventional exchange, where liquidity worsens. In aggregate, implementing a latency delay worsens total expected welfare. We find that the impact on price discovery depends on the relative abundance of speculators. If the exchange with delay technology competes against a conventional exchange, it implements a delay only if it has sufficiently low market share.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 8 , December 2020 , pp. 2555 - 2587
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2020

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Footnotes

We thank an anonymous referee, Hendrik Bessembinder (the editor), Eric Budish, Sabrina Buti, Sarah Draus, Sean Foley, Corey Garriott, Michael Goldstein, Terrence Hendershott, Peter Hoffmann, Katya Malinova, Albert Menkveld, Carol Osler, Andreas Park, Andriy Shkilko, Adrian Walton, Bart Yueshen, and Marius Zoican; participants at the 2017 Stern Microstructure Conference, the 2017 Erasmus Rotterdam School of Management (RSM) Liquidity Conference, the 2017 Sustainable Architecture for Finance in Europe Market Microstructure Conference, the 2017 European Finance Association Annual Meeting, the 2017 Northern Finance Association Annual Meeting, and the 2017 Canadian Economics Association Annual Meeting; and participants at seminars at the Bank of Canada, the University of Ontario Institute of Technology, the University of Toronto, and Wilfrid Laurier University for valuable discussions and comments. We also thank William Wootton for valuable research assistance. Brolley acknowledges financial support by the Social Sciences and Humanities Research Council of Canada Insight Development Grant program (grant 430-2016-00279). All errors are our own.

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