High-Frequency Trading in Limit Order Markets: Equilibrium Impact and Regulation

Jakub Rojcek and Alexandre Ziegler
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Jakub Rojcek: University of Zurich and Swiss Finance Institute
Alexandre Ziegler: University of Zurich and Swiss Finance Institute

No 15-23, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We investigate the impact of high-frequency trading (HFT) on market quality and investor welfare using a general limit order book model. We find that while the presence of HFT always improves market quality under symmetric information, under asymmetric information this is the case only if competition between high-frequency traders is sufficiently strong. While HFT does not negatively impact investor welfare, it reduces the welfare of slow speculators. The flexibility of the model allows investigating the effect of the main recent regulatory initiatives designed to curb HFT on market quality and investor welfare. We consider time-in-force rules, cancellation fees, transaction taxes, rebate fee structures, and speed bumps. While some of these regulations lead to improvements in a number of market quality measures, this generally does not translate into higher welfare for long-term investors. Rather, the main effect of such regulations is to generate wealth transfers from high-frequency traders to slow speculators. These regulations therefore appear inadequate to enhance investor welfare in the presence of HFTs. Of the different measures, transaction taxes are the least harmful; while they reduce welfare roughly by the amount of the tax, they do not significantly worsen market quality. The common practice by exchanges of granting rebates to limit orders is detrimental to market quality and investor welfare, causing both higher effective spreads and longer execution times.

Keywords: High-frequency trading; Regulation; Market quality (search for similar items in EconPapers)
JEL-codes: C63 C73 D82 G14 G28 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2015-06, Revised 2015-07
New Economics Papers: this item is included in nep-mst
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1523

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