Hostname: page-component-cd9895bd7-fscjk Total loading time: 0 Render date: 2024-12-20T01:56:13.296Z Has data issue: false hasContentIssue false
  • English
  • Français

High-Frequency Trading Competition

Published online by Cambridge University Press:  19 September 2018

Jonathan Brogaard  and
Corey Garriott
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

Theory on high-frequency traders (HFTs) predicts that market liquidity for a security decreases in the number of HFTs trading the security. We test this prediction by studying a new Canadian stock exchange, Alpha, that experienced the entry of 11 HFTs over 4 years. We find that bid–ask spreads on Alpha converge to those at the Toronto Stock Exchange as more HFTs trade on Alpha. Effective and realized spreads for non-HFTs improve as HFTs enter the market. To explain the contrast with theory, which models the HFT as a price competitor, we provide evidence more consistent with HFTs fitting a quantity-competitor framework.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 4 , August 2019 , pp. 1469 - 1497
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Footnotes

1

We are grateful to Michael Brolley, David Cimon, Jennifer Conrad (the editor), Thierry Foucault, Bjorn Hagströmer, Terry Hendershott, Oleksiy Kryvstov, Albert Menkveld, Pamela Moulton, Christopher Parsons, Talis Putnins, Ryan Riordan, Gideon Saar, Mehrdad Samadi (the referee), and Joshua Slive for their many suggestions to improve the article; to seminar participants at the Canadian Economic Association, Canadian Imperial Bank of Commerce, Financial Risks International Forum, Ontario Securities Commission, Society for Financial Studies (SFS) Cavalcade, Stockholm Business School, Vienna High-Frequency Trading (HFT): Curse or Blessing, and the Western Financial Association; and to Adrian Eng and Faith Chin for their research assistance. This article is an extension of the Bank of Canada working paper by the same name. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. All errors are our own.

References

Aït-Sahalia, Y., and Sağlam, M.. “High Frequency Market Making: Optimal Quoting.” Working Paper, available at https://ssrn.com/abstract=2331613 (2013).Google Scholar
Baron, M. D.; Brogaard, J.; Hagströmer, B.; and Kirilenko, A. A.. “Risk and Return in High-Frequency Trading.” Journal of Financial and Quantitative Analysis, 54 (2019), 993–1024.Google Scholar
Bertrand, M.; Duflo, E.; and Mullainathan, S.. “How Much Should We Trust Differences-in-Differences Estimates?” Quarterly Journal of Economics, 119 (2004), 249–275.Google Scholar
Biais, B.; Foucault, T.; and Moinas, S.. “Equilibrium Fast Trading.” Journal of Financial Economics, 116 (2015), 292–313.Google Scholar
Biais, B.; Martimort, D.; and Rochet, J. C.. “Competing Mechanisms in a Common Value Environment.” Econometrica, 68 (2000), 799–837.Google Scholar
Boehmer, E.; Li, D.; and Saar, G.. “The Competitive Landscape of High-Frequency Trading Firms.” Review of Financial Studies, 31 (2018), 2227–2276.Google Scholar
Bondarenko, O.“Competing Market Makers, Liquidity Provision, and Bid–Ask Spreads.” Journal of Financial Markets, 4 (2001), 269–308.Google Scholar
Breckenfelder, J. H.“Competition between High-Frequency Traders, and Market Quality.” Munich Personal RePEc Archive Working Paper (2013).Google Scholar
Bresnahan, T. F.“Empirical Studies of Industries with Market Power.” In Handbook of Industrial Organization, Vol. 2, Schmalensee, R. and Willig, R., eds. Amsterdam, Netherlands: Elsevier (1989).Google Scholar
Brogaard, J.; Hendershott, T.; and Riordan, R.. “High-Frequency Trading and Price Discovery.” Review of Financial Studies, 27 (2014), 2267–2306.Google Scholar
Budish, E. B.; Cramton, P.; and Shim, J. J.. “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response.” Quarterly Journal of Economics, 130 (2015), 1547–1621.Google Scholar
Ellis, K.; Michaely, R.; and O’Hara, M.. “The Making of a Dealer Market: From Entry to Equilibrium in the Trading of Nasdaq Stocks.” Journal of Finance, 57 (2002), 2289–2316.Google Scholar
Fischer, S.“Is There a Liquidity Problem Post-Crisis?” Speech at the Initiative on Business and Public Policy at the Brookings Institution, Washington, DC (Nov. 15, 2016).Google Scholar
Ho, T., and Stoll, H. R.. “On Dealer Markets under Competition.” Journal of Finance, 35 (1980), 259–267.Google Scholar
Hoffmann, P.“A Dynamic Limit Order Market with Fast and Slow Traders.” Journal of Financial Economics, 113 (2014), 156–169.Google Scholar
Jones, C. M.“What Do We Know about High-Frequency Trading?” Working Paper, Columbia University (2013).Google Scholar
Kirilenko, A.; Kyle, A. S.; Samadi, M.; and Tuzun, T.. “The Flash Crash: High-Frequency Trading in an Electronic Market.” Journal of Finance, 72 (2017), 967–998.Google Scholar
Kyle, A. S.“Informed Speculation with Imperfect Competition.” Review of Economic Studies, 56 (1989), 317–355.Google Scholar
Menkveld, A. J.“High Frequency Trading and the New Market Makers.” Journal of Financial Markets, 16 (2013), 712–740.Google Scholar
Menkveld, A. J., and Zoican, M. A.. “Need for Speed? Exchange Latency and Liquidity.” Review of Financial Studies, 30 (2017), 1188–1228.Google Scholar
O’Hara, M.; Saar, G.; and Zhong, Z.. “Relative Tick Size and the Trading Environment.” Review of Asset Pricing Studies, forthcoming (2019).Google Scholar
Petersen, M. A.“Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435–480.Google Scholar
Subrahmanyam, A.“Risk Aversion, Market Liquidity, and Price Efficiency.” Review of Financial Studies, 4 (1991), 417–441.Google Scholar
Thompson, S. B.“Simple Formulas for Standard Errors That Cluster by Both Firm and Time.” Journal of Financial Economics, 99 (2011), 1–10.Google Scholar
Tirole, J. The Theory of Industrial Organization. Cambridge, MA: MIT Press (1988).Google Scholar
Supplementary material: File

Brogaard and Garriott supplementary material

Internet Appendix

Download Brogaard and Garriott supplementary material(File)
File 120.5 KB