A dynamic limit order market with fast and slow traders

Peter Hoffmann

No 1526, Working Paper Series from European Central Bank

Abstract: We study the role of high-frequency trading in a dynamic limit order market. Being fast is valuable because it enables traders to revise outstanding limit orders upon news arrivals when interacting with slow market participants. On the one hand, the existence of fast traders can help to reduce the inefficiency that is rooted in the risk of being "picked off" after unfavourable price movements and therefore allows more gains from trade to be realized. On the other hand, slow traders face a relative loss in bargaining power which leads them to strategically submit limit orders with a lower execution probability, thereby reducing trade. Due to this negative externality, the equilibrium level of investment is always welfare-reducing. The model generates additional testable implications regarding the effects of high-frequency trading on order flow statistics. JEL Classification: G19, C72, D62

Keywords: high-frequency trading; limit order market (search for similar items in EconPapers)
Date: 2013-03
New Economics Papers: this item is included in nep-mst
Note: 1137913
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Citations: View citations in EconPapers (1)

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