The Welfare Effects of Financial Innovation: High-Frequency Trading in Equity Markets

Thomas Philippon () and Emiliano S. Pagnotta
Additional contact information
Emiliano S. Pagnotta: NYU Stern

No 1246, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: The financial crisis has demonstrated the need to better analyze financial innovations. While some of these innovations are beneficial, others do not improve overall welfare and create unacceptable risks for the economy. A major impediment to efficient regulation is the lack of research assessing the social value of financial innovations. In this paper we aim to provide a comprehensive analysis of high frequency trading (HFT) in equity markets. HFT is an important innovation whose social value is open to heated debate. Understanding its consequences is key to evaluate the impact of equity trading on economic activity, but also to assess whether ultra-fast computerized trading may affect a market’s systemic stability. We develop a dynamic model of trading activity with heterogeneous trading technologies and derive testable welfare implications. In order to quantify the costs and benefits of HFT, we exploit a proprietary NASDAQ dataset that allows us to observe the actions of the innovators (high frequency traders) and study their effect on market aggregates and other participants’ investment decisions. Besides equity markets, we expect that our analysis will prove useful to anticipate impacts in a much larger class of assets for which HFT is or will become increasingly important, like derivative markets, and for studying financial innovation more broadly.

Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://red-files-public.s3.amazonaws.com/meetpapers/2011/paper_1246.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:red:sed011:1246

Access Statistics for this paper

More papers in 2011 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Christian Zimmermann ().