Working Paper: NBER ID: w19531
Authors: Yacine Atsahalia; Mehmet Saglam
Abstract: We propose a model of dynamic trading where a strategic high frequency trader receives an imperfect signal about future order flows, and exploits his speed advantage to optimize his quoting policy. We determine the provision of liquidity, order cancellations, and impact on low frequency traders as a function of both the high frequency trader's latency, and the market volatility. The model predicts that volatility leads high frequency traders to reduce their provision of liquidity. Finally, we analyze the impact of various policies designed to potentially regulate high frequency trading.
Keywords: High Frequency Trading; Market Liquidity; Regulatory Policies
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Latency (C41) | Higher profits (D33) |
| Latency (C41) | Greater liquidity provision (E51) |
| Latency (C41) | Higher order cancellation rates (C69) |
| Increased market volatility (G19) | Decreased liquidity provision (E44) |
| Competition among HFTs (D41) | Increased liquidity provision (E51) |
| Competition among HFTs (D41) | Improved outcomes for low frequency traders (LFTs) (G14) |