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Strategic Speed Choice by High-Frequency Traders under Speed Bumps

Jun Aoyagi

ISER Discussion Paper from Institute of Social and Economic Research, Osaka University

Abstract: We study how high-frequency traders (HFTs) strategically decide their speed level in a market with a random speed bump. If HFTs recognize the market impact of their speed decision, they perceive a wider bid-ask spread as an endogenous upward-sloping cost of being faster. We find that the speed elasticity of the bid-ask spread (slope of the endogenous cost function) negatively depends on the expected length of a speed bump since a longer delay makes market makers insensitive to HFTs' speed increment. Hence, speed bumps promote the investment of HFTs in high-speed technology by reducing the marginal cost of getting faster, undermining their intended purpose of protecting market makers. Depending on the expected length of a bump, an arms race among HFTs exhibits both complementarity and substitution. These findings explain the ambiguous empirical results regarding speed bumps and adverse selection for market makers.

Date: 2019-02
New Economics Papers: this item is included in nep-mst
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