nep-mst New Economics Papers
on Market Microstructure
Issue of 2025–09–29
five papers chosen by
Thanos Verousis, Vlerick Business School


  1. The speed premium: high-frequency trading and the cost of capital By Matteo Aquilina; Gbenga Ibikunle; Khaladdin Rzayev; Xuesi Wang
  2. Competition and Incentives in a Shared Order Book By Ren\'e A\"id; Philippe Bergault; Mathieu Rosenbaum
  3. Ultrafast Extreme Events: Empirical Analysis of Mechanisms and Recovery in a Historical Perspective By Luca Henrichs; Anton J. Heckens; Thomas Guhr
  4. Bootstrapping Liquidity in BTC-Denominated Prediction Markets By Fedor Shabashev
  5. A survey of statistical arbitrage pair trading with machine learning, deep learning, and reinforcement learning methods By Yufei Sun

  1. By: Matteo Aquilina; Gbenga Ibikunle; Khaladdin Rzayev; Xuesi Wang
    Abstract: When trading in financial markets reaches light speed, does the real economy slow down? Using co-location and latency improvement upgrades at NASDAQ as natural experiments, we find that, on average, high frequency trading (HFT) leads to higher cost of capital. However, the impact is not uniform. HFT raises the cost of capital for low-beta stocks by amplifying their systematic risk, as HFT's correlated trading strategies make these stocks more responsive to market-wide information. For the most liquid stocks, HFT reduces the cost of capital by lowering the liquidity premium required by investors. A complementary test using data from the unfragmented Hong Kong market shows that these causal effects are not due to market fragmentation and persist across countries and market structures. Our results demonstrate that HFT's real economic effects are heterogeneous across stock characteristics, with important implications for financial market regulation and policy design.
    Keywords: high frequency trading, cost of capital, financial innovation, liquidity, systematic risk
    JEL: G12 G14 G15
    Date: 2025–09
    URL: https://d.repec.org/n?u=RePEc:bis:biswps:1290
  2. By: Ren\'e A\"id; Philippe Bergault; Mathieu Rosenbaum
    Abstract: Recent regulation on intraday electricity markets has led to the development of shared order books with the intention to foster competition and increase market liquidity. In this paper, we address the question of the efficiency of such regulations by analysing the situation of two exchanges sharing a single limit order book, i.e. a quote by a market maker can be hit by a trade arriving on the other exchange. We develop a Principal-Agent model where each exchange acts as the Principal of her own market maker acting as her Agent. Exchanges and market makers have all CARA utility functions with potentially different risk-aversion parameters. In terms of mathematical result, we show existence and uniqueness of the resulting Nash equilibrium between exchanges, give the optimal incentive contracts and provide numerical solution to the PDE satisfied by the certainty equivalent of the exchanges. From an economic standpoint, our model demonstrates that incentive provision constitutes a public good. More precisely, it highlights the presence of a competitiveness spillover effect: when one exchange optimally incentivizes its market maker, the competing exchange also reaps indirect benefits. This interdependence gives rise to a free-rider problem. Given that providing incentives entails a cost, the strategic interaction between exchanges may lead to an equilibrium in which neither platform offers incentives -- ultimately resulting in diminished overall competition.
    Date: 2025–09
    URL: https://d.repec.org/n?u=RePEc:arx:papers:2509.10094
  3. By: Luca Henrichs; Anton J. Heckens; Thomas Guhr
    Abstract: To understand the emergence of Ultrafast Extreme Events (UEEs), the influence of algorithmic trading or high-frequency traders is of major interest as they make it extremely difficult to intervene and to stabilize financial markets. In an empirical analysis, we compare various characteristics of UEEs over different years for the US stock market to assess the possible non-stationarity of the effects. We show that liquidity plays a dominant role in the emergence of UEEs and find a general pattern in their dynamics. We also empirically investigate the after-effects in view of the recovery rate. We find common patterns for different years. We explain changes in the recovery rate by varying market sentiments for the different years.
    Date: 2025–09
    URL: https://d.repec.org/n?u=RePEc:arx:papers:2509.10376
  4. By: Fedor Shabashev
    Abstract: Prediction markets have gained adoption as on-chain mechanisms for aggregating information, with platforms such as Polymarket demonstrating demand for stablecoin-denominated markets. However, denominating in non-interest-bearing stablecoins introduces inefficiencies: participants face opportunity costs relative to the fiat risk-free rate, and Bitcoin holders in particular lose exposure to BTC appreciation when converting into stablecoins. This paper explores the case for prediction markets denominated in Bitcoin, treating BTC as a deflationary settlement asset analogous to gold under the classical gold standard. We analyse three methods of supplying liquidity to a newly created BTC-denominated prediction market: cross-market making against existing stablecoin venues, automated market making, and DeFi-based redirection of user trades. For each approach we evaluate execution mechanics, risks (slippage, exchange-rate risk, and liquidation risk), and capital efficiency. Our analysis shows that cross-market making provides the most user-friendly risk profile, though it requires active professional makers or platform-subsidised liquidity. DeFi redirection offers rapid bootstrapping and reuse of existing USDC liquidity, but exposes users to liquidation thresholds and exchange-rate volatility, reducing capital efficiency. Automated market making is simple to deploy but capital-inefficient and exposes liquidity providers to permanent loss. The results suggest that BTC-denominated prediction markets are feasible, but their success depends critically on the choice of liquidity provisioning mechanism and the trade-off between user safety and deployment convenience.
    Date: 2025–09
    URL: https://d.repec.org/n?u=RePEc:arx:papers:2509.11990
  5. By: Yufei Sun (Faculty of Economic Sciences, University of Warsaw)
    Abstract: Pair trading remains a cornerstone strategy in quantitative finance, having consistently attracted scholarly attention from both economists and computer scientists. Over recent decades, research has expanded beyond traditional linear frameworks—such as regression- and cointegration-based models—to embrace advanced methodologies, including machine learning (ML), deep learning (DL), reinforcement learning (RL), and deep reinforcement learning (DRL). These techniques have demonstrated superior capacity to capture nonlinear dependencies and complex dynamics in financial data, thereby enhancing predictive performance and strategy design. Building on these academic developments, practitioners are increasingly deploying DL models to forecast asset price movements and volatility in equity and foreign exchange markets, leveraging the advantages of artificial intelligence (AI) for trading. In parallel, DRL has gained prominence in algorithmic trading, where agents can autonomously learn optimal trading policies by interacting with market environments, enabling systems that move beyond price prediction to dynamic signal generation and portfolio allocation. This paper provides a comprehensive survey of ML-, DL-, RL-, and DRL-based approaches to pair trading within quantitative finance. By systematically reviewing existing studies and highlighting their methodological contributions, it offers researchers a structured foundation for replication and further development. In addition, the paper outlines promising avenues for future research that extend the application of AI-driven methods in statistical arbitrage and market microstructure analysis.
    Keywords: Pair Trading, Machine Learning, Deep Learning, Reinforcement Learning, Deep Reinforcement Learning, Artificial Intelligence, Quantitative Trading
    JEL: C4 C45 C55 C65 G11
    Date: 2025
    URL: https://d.repec.org/n?u=RePEc:war:wpaper:2025-22

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