Quantifying the High-Frequency Trading "Arms Race"

Matteo Aquilina, Eric Budish and Peter O'Neill

No 29011, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We use stock exchange message data to quantify the negative aspect of high-frequency trading, known as “latency arbitrage.” The key difference between message data and widely-familiar limit order book data is that message data contain attempts to trade or cancel that fail. This allows the researcher to observe both winners and losers in a race, whereas in limit order book data you cannot see the losers, so you cannot directly see the races. We find that latency-arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5-10 millionths of a second), and account for a remarkably large portion of overall trading volume (about 20%). Race participation is concentrated, with the top 6 firms accounting for over 80% of all race wins and losses. The average race is worth just a small amount (about half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market's cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

JEL-codes: D47 G1 G12 G14 (search for similar items in EconPapers)
Date: 2021-07
New Economics Papers: this item is included in nep-cwa, nep-mst and nep-ore
Note: AP CF IO
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Published as Matteo Aquilina & Eric Budish & Peter O’Neill, 2021. "Quantifying the High-Frequency Trading “Arms Race”," The Quarterly Journal of Economics, vol 137(1), pages 493-564.

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Journal Article: Quantifying the High-Frequency Trading “Arms Race” (2022)
Working Paper: Quantifying the high-frequency trading "arms race" (2021)
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