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on Market Microstructure |
| By: | Jakub ROJCEK (University of Zurich and Swiss Finance Institute); Alexandre ZIEGLER (University of Zurich and Swiss Finance Institute) |
| Abstract: | We investigate the impact of high-frequency trading (HFT) on market quality and investor welfare using a general limit order book model. We find that while the presence of HFT always improves market quality under symmetric information, under asymmetric information this is the case only if competition between high-frequency traders is sufficiently strong. While HFT does not negatively impact investor welfare, it reduces the welfare of slow speculators. The flexibility of the model allows investigating the effect of the main recent regulatory initiatives designed to curb HFT on market quality and investor welfare. We consider time-in-force rules, cancellation fees, transaction taxes, rebate fee structures, and speed bumps. While some of these regulations lead to improvements in a number of market quality measures, this generally does not translate into higher welfare for long-term investors. Rather, the main effect of such regulations is to generate wealth transfers from high-frequency traders to slow speculators. These regulations therefore appear inadequate to enhance investor welfare in the presence of HFTs. Of the different measures, transaction taxes are the least harmful; while they reduce welfare roughly by the amount of the tax, they do not significantly worsen market quality. The common practice by exchanges of granting rebates to limit orders is detrimental to market quality and investor welfare, causing both higher effective spreads and longer execution times. |
| Keywords: | High-frequency trading, Regulation, Market quality |
| JEL: | G14 G28 C63 C73 D82 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1523&r=mst |
| By: | Ramazan Gencay (Simon Fraser University); Soheil Mahmoodzadeh (University of Cambridge - Faculty of Economics); Jakub Rojcek (University of Zurich, Department of Banking and Finance; Swiss Finance Institute); Michael C Tseng (Simon Fraser University (SFU) - Department of Economics) |
| Abstract: | This paper analyzes brief episodes of high-intensity quotes turnover and revision-"bursts" in quotes-in the U.S. equity market. Such events occur very frequently, around 400 times a day for actively traded stocks. We find significant price impact associated to this market-maker initiated event, about five times higher than during non-burst periods. Bursts in quotes are concurrent with short-lived structural break in the informational relationship between market makers and market takers. During bursts, market makers no longer passively impound information from order flow into quotes---a departure from traditional market microstructure paradigm. Rather, market makers significantly impact prices during bursts in quotes. Further analysis shows that there is asymmetry in adverse selection between the bid and ask sides of the limit order book and only a sub-population of market makers enjoy an informational advantage during bursts. Our results call attention to the need for a new microstructure perspective in understanding modern high-frequency limit order book markets. |
| Keywords: | Price Impact, Burst, High-Frequency Trading, Market Quality, Adverse Selection |
| JEL: | G14 G28 C58 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1621&r=mst |
| By: | Pierre Collin-Dufresne (Ecole Polytechnique Fédérale de Lausanne , Swiss Finance Institute, and National Bureau of Economic Research (NBER)); Vyacheslav Fos (Boston College); Dmitriy Muravyev (Boston College) |
| Abstract: | Using a comprehensive sample of trades from Schedule 13D filings by activist investors, we study how option prices respond to informed trading in the stock market. We show that this class of informed traders chooses to trade stocks and to not trade derivatives in more than 97% of cases, suggesting that most of informed trading by activist shareholders takes place in the stock market. We find that on days when activists accumulate shares, option implied volatility decreases and volatility skew increases. These changes are consistent with the drop in realized volatility we observe around the filing date. We also find that measures of adverse selection increase for options but decrease for stocks on days when Schedule 13D filers trade in stocks. Option markets seem to reflect valuable volatility specific information. |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1555&r=mst |
| By: | Johannes Muhle-Karbe (ETH Zurich and Swiss Finance Institute); Kevin Webster (Princeton University) |
| Abstract: | We propose an equilibrium model for the short-term informational advantages crucial in high-frequency trading. In this setting, risk-neutral insiders hold martingale inventories. In contrast, inventory aversion leads to autoregressive positions. These vanish in the continuous-time limit, while still yielding approximately the same returns. This illustrates how high-frequency trading allows to monetize information with very little inventory risk. |
| Keywords: | high frequency trading, information asymmetry, inventory management |
| JEL: | G14 G11 C61 C68 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1535&r=mst |