Hoffmann, Peter (2012): A dynamic limit order market with fast and slow traders.
Download (2MB) | Preview
We study a dynamic limit order market where agents may invest into a trading technology that grants them a speed advantage over others. Being fast is valuable because it allows limit orders to be revised quickly in the light of new information and therefore reduces the risk of being picked off. Even though this can generate more trading, the equilibrium level of investment is excessive and always generates a welfare loss because fast traders exert negative externalities on slow agents and are able to extract any surplus. If the diffusion of trading technology additionally leads to a more efficient trading process, this result may reverse completely. For sufficiently large efficiency gains, fast traders exert positive externalities on slow market participants and their presence leads to an increase in social welfare, albeit the equilibrium level of investment is below the social optimum. Our results imply that the marginal impact of investments related to algorithmic and high-frequency trading on social welfare crucially depends on the pre-investment level of market efficiency.
|Item Type:||MPRA Paper|
|Original Title:||A dynamic limit order market with fast and slow traders|
|Keywords:||Algorithmic Trading, Limit Order Market, Welfare, Investment|
|Subjects:||D - Microeconomics > D6 - Welfare Economics > D62 - Externalities
G - Financial Economics > G1 - General Financial Markets > G19 - Other
C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C72 - Noncooperative Games
|Depositing User:||Peter Hoffmann|
|Date Deposited:||05. Jul 2012 12:41|
|Last Modified:||07. Sep 2015 23:09|
Biais, B., Foucault, T., and Moinas, S. (2011), "Equilibrium High Frequency Trading", Working Paper
Biais, B., and Woolley, P. (2011), "High Frequency Trading", Working Paper
Boehmer, E., Fong, K. Y. L., and Wu, J. (2012) "International Evidence on Algorithmic Trading", Working Paper
Brogaard, J. (2010) "The Activity of High Frequency Traders", Working Paper
Brogaard, J. (2011) "High Frequency Trading and Volatility", Working Paper
Cartea, A., and Penalva, J. (2011) "Where is the value in high-frequency trading", Working Paper
Chaboud, A., Chiquoine, B., Hjalmarsson, E., and Vega, C. (2009), "Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market", Working Paper
Colliard, J.-E., and Foucault, T. (2012) "Trading Fees and Efficiency in limit order markets", Review of Financial Studies, forthcoming
Copeland, T. E., and Galai, D. (1983), "Information effects on the bid-ask spread", Journal of Finance, Vol. 38, No. 5: 1457-69
Foucault, T. (1999) "Order Flow Composition and Trading Costs in a dynamic limit order market", Journal of Financial Markets, Vol. 2, No. 2: 99-134.
Foucault, T. (2012),"Algorithmic Trading: Issues and Preliminary Evidence", forthcoming in "Market Microstructure: Confronting Many Viewpoints", John Wiley & Sons
Foucault, T., Röell, A., and Sandås, P. (2003) "Market Making with Costly Monitoring: An Analysis of the SOES Controversy", Review of Financial Studies, Vol. 16, No. 2: 345-84.
Garvey, R. and Wu, F. (2010) "Speed, distance, and electronic trading: New evidence on why location matters", Journal of Financial Markets, Vol. 13, No 4: 367-396.
Goettler, R., Parlour, C. A., and Rajan, U. (2009) "Informed Traders and Limit Order Markets", Journal of Financial Economics, Vol. 93, No. 1: 67--87
Hasbrouck, J., and Saar, G. (2009) "Trading and technology: The blurring of traditional definitions", Journal of Financial Markets, Vol. 12, No. 2: 143-172
Hasbrouck, J., and Saar, G. (2011) "Low-latency trading", Working Paper
Hendershott, T., Jones, C., and Menkveld, A. (2011) "Does algorithmic trading improve liquidity?", Journal of Finance, Vol. 66, No. 1: 1-33.
Hendershott, T., and Riordan, R. (2011a) "Algorithmic Trading and the Market for Liquidity ", Journal of Financial and Quantitative Analysis, forthcoming
Hendershott, T., and Riordan, R. (2011b) "High-frequency trading and price discovery", Working Paper
Jovanovic, B., and Menkveld, A. (2011), "Middlemen in Securities Markets", Working Paper
Kirilenko, A., Kyle, A., Samadi, M., and Tuzun, T. (2011) "The Flash Crash: The Impact of High-Frequency Trading on an Electronic Market", Working Paper
Liu, W. M. (2009) "Monitoring and limit order submission risks", Journal of Financial Markets, Vol. 12, No. 1: 107-41.
Menkveld (2011) "High-frequency trading and the new-market makers", Working Paper
Moallemi, C. C., and Saglam, M. (2011) "The cost of latency", Working Paper
Skjeltorp, J. A., Sojli, E., and Tham, W. W. (2011) "Sunshine Trading: Flashes of Trading Intent at the NASDAQ", Working Paper
Available Versions of this Item
- A dynamic limit order market with fast and slow traders. (deposited 05. Jul 2012 12:41) [Currently Displayed]