Working Paper: CEPR ID: DP15848
Authors: Thomas Gehrig; Klaus Ritzberger
Abstract: This paper analyses the role of intermediaries in providing immediacy in fast markets. Fast markets are modelled as contests with the possibility of multiple winners where the probability of casting the best quote depends on prior technology investments. Depending on the market design, equilibrium pricing by intermediaries involves a trade-off, between monopolistic price distortion and excess volatility. Since equilibrium at the pricing stage generates an externality, investments into faster trading technologies are necessarily asymmetric in equilibrium, akin to markets with vertical product differentiation. Further, equilibrium is not necessarily effcient, since it is possible that a high-cost intermediary ends up investing excessively and thus trades more frequently than low-cost rivals.
Keywords: High-frequency trading; Intermediation; Market design; Price volatility
JEL Codes: D43; D47; G14; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| technology investments (G31) | market power dynamics (L11) |
| equilibrium pricing (D41) | excess volatility (G17) |
| randomized pricing (D49) | price volatility (G13) |
| market speed (G10) | price volatility (G13) |