High Frequency Trading and Fragility
Giovanni Cespa and
Xavier Vives
No D/1161, IESE Research Papers from IESE Business School
Abstract:
We show that limited dealer participation in the market, coupled with an informational friction resulting from high frequency trading, can induce demand for liquidity to be upward sloping and strategic complementarities in traders' liquidity consumption decisions: traders demand more liquidity when the market becomes less liquid, which in turn makes the market more illiquid, fostering the initial demand hike. This can generate market instability, where an initial dearth of liquidity degenerates into a liquidity rout (as in a flash crash). While in a transparent market, liquidity is increasing in the proportion of high frequency traders, in an opaque market strategic complementarities can make liquidity U-shaped in this proportion as well as in the degree of transparency.
Keywords: Market fragmentation; high frequency trading; flash crash; asymmetric information (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2017-01-16
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http://www.iese.edu/research/pdfs/WP-1161-E.pdf (application/pdf)
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Working Paper: High frequency trading and fragility (2017) 
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:iesewp:d-1161
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