Hostname: page-component-78c5997874-94fs2 Total loading time: 0 Render date: 2024-11-15T12:03:08.223Z Has data issue: false hasContentIssue false
  • English
  • Français

Order-Flow Segmentation, Liquidity, and Price Discovery: The Role of Latency Delays

Published online by Cambridge University Press:  13 May 2020

Michael Brolley Open the ORCID record for Michael Brolley [Opens in a new window]  and
David A. Cimon Open the ORCID record for David A. Cimon [Opens in a new window]
Michael Brolley*
Affiliation:
Brolley, mbrolley@wlu.ca, Wilfrid Laurier University
David A. Cimon
Affiliation:
Cimon, dcimon@wlu.ca, Wilfrid Laurier University
*
Brolley (corresponding author), mbrolley@wlu.ca
Get access Rights & Permissions [Opens in a new window]

Abstract

Latency delays intentionally slow order execution at an exchange, often to protect market makers against latency arbitrage. We study informed trading in a fragmented market in which one exchange introduces a latency delay on market orders. Liquidity improves at the delayed exchange as informed investors emigrate to the conventional exchange, where liquidity worsens. In aggregate, implementing a latency delay worsens total expected welfare. We find that the impact on price discovery depends on the relative abundance of speculators. If the exchange with delay technology competes against a conventional exchange, it implements a delay only if it has sufficiently low market share.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 8 , December 2020 , pp. 2555 - 2587
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2020

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank an anonymous referee, Hendrik Bessembinder (the editor), Eric Budish, Sabrina Buti, Sarah Draus, Sean Foley, Corey Garriott, Michael Goldstein, Terrence Hendershott, Peter Hoffmann, Katya Malinova, Albert Menkveld, Carol Osler, Andreas Park, Andriy Shkilko, Adrian Walton, Bart Yueshen, and Marius Zoican; participants at the 2017 Stern Microstructure Conference, the 2017 Erasmus Rotterdam School of Management (RSM) Liquidity Conference, the 2017 Sustainable Architecture for Finance in Europe Market Microstructure Conference, the 2017 European Finance Association Annual Meeting, the 2017 Northern Finance Association Annual Meeting, and the 2017 Canadian Economics Association Annual Meeting; and participants at seminars at the Bank of Canada, the University of Ontario Institute of Technology, the University of Toronto, and Wilfrid Laurier University for valuable discussions and comments. We also thank William Wootton for valuable research assistance. Brolley acknowledges financial support by the Social Sciences and Humanities Research Council of Canada Insight Development Grant program (grant 430-2016-00279). All errors are our own.

References

Aldrich, E. M., and Friedman, D.. “Order Protection through Delayed Messaging.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2999059 (2019).Google Scholar
Anderson, L.; Andrews, E.; Devani, B.; Mueller, M.; and Walton, A.. “Speed Segmentation on Exchanges: Competition for Slow Flow.” Bank of Canada Staff Working Paper No. 2018-3 (2018).Google Scholar
Angel, J. J.; Harris, L. E.; and Spatt, C. S.. “Equity Trading in the 21st Century.” Quarterly Journal of Finance, 1 (2011), 1–53.CrossRefGoogle Scholar
Aoyagi, J.“Strategic Speed Choice by High-Frequency Traders Under Speed Bumps.” ISER Discussion Paper No. 1050 (2019).CrossRefGoogle Scholar
Baldauf, M., and Mollner, J.. “High-Frequency Trading and Market Performance.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2674767 (2018).CrossRefGoogle Scholar
Battalio, R. H.“Third Market Broker-Dealers: Cost Competitors or Cream Skimmers?” Journal of Finance, 52 (1997), 341–352.CrossRefGoogle Scholar
Battalio, R. H.; Corwin, S. A.; and Jennings, R.. “Can Brokers Have It All? On The Relation Between Make-Take Fees and Limit Order Execution Quality.” Journal of Finance, 71 (2016), 2193–2238.CrossRefGoogle Scholar
Bessembinder, H.; Hao, J.; and Zheng, K.. “Market Making Contracts, Firm Value, and the IPO Decision.” Journal of Finance, 70 (2015), 1997–2028.CrossRefGoogle Scholar
Biais, B.; Foucault, T.; and Moinas, S.. “Equilibrium Fast Trading.” Journal of Financial Economics, 116 (2015), 292–313.CrossRefGoogle Scholar
Brogaard, J., and Garriott, C.. “High-Frequency Trading Competition.” Journal of Financial and Quantitative Analysis, 54 (2019), 1469–1498.CrossRefGoogle Scholar
Brogaard, J.; Hagströmer, B.; Nordén, L.; and Riordan, R.. “Trading Fast and Slow: Colocation and Liquidity.” Review of Financial Studies, 28 (2015), 3407–3443.CrossRefGoogle Scholar
Brogaard, J.; Hendershott, T.; and Riordan, R.. “High-Frequency Trading and Price Discovery.” Review of Financial Studies, 27 (2014), 2267–2306.CrossRefGoogle Scholar
Brogaard, J.; Hendershott, T.; and Riordan, R.. “Price Discovery Without Trading: Evidence from Limit Orders.” Journal of Finance, 74 (2019), 1621–1658.CrossRefGoogle Scholar
Budish, E.; Cramton, P.; and Shim, J.. “The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response.” Quarterly Journal of Economics, 130 (2015), 1547–1621.CrossRefGoogle Scholar
Buti, S.; Consonni, F.; Rindi, B.; Wen, Y.; and Werner, I. M.. “Sub-Penny and Queue-Jumping.” Dice Center Working Paper 2013-18 (2015).CrossRefGoogle Scholar
Carrion, A.“Very Fast Money: High-Frequency Trading on the NASDAQ.” Journal of Financial Markets, 16 (2013), 680–711.CrossRefGoogle Scholar
Chakrabarty, B.; Huang, J.; and Jain, P.. “Effects of a Speed Bump on Market Quality and Exchange Competition.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3280645 (2018).CrossRefGoogle Scholar
Chakrabarty, B.; Jain, P. K.; Shkilko, A.; and Sokolov, K.. “Speed of Market Access and Market Quality: Evidence from the SEC Rule 15c3-5.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2328231 (2014).Google Scholar
Chen, H.; Foley, S.; Goldstein, M. A.; and Ruf, T.. “The Value of a Millisecond: Harnessing Information in Fast, Fragmented Markets.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2860359 (2017).Google Scholar
Cimon, D. A.“Broker Routing Decisions in Limit Order Markets.” Bank of Canada Staff Working Paper No. 2016-50 (2019).CrossRefGoogle Scholar
Colliard, J.-E., and Foucault, T.. “Trading Fees and Efficiency in Limit Order Markets.” Review of Financial Studies, 25 (2012), 3389–3421.CrossRefGoogle Scholar
Conrad, J.; Wahal, S.; and Xiang, J.. “High-Frequency Quoting, Trading, and the Efficiency of Prices.” Journal of Financial Economics, 116 (2015), 271–291.CrossRefGoogle Scholar
Foucault, T., and Menkveld, A. J.. “Competition for Order Flow and Smart Order Routing Systems.” Journal of Finance, 63 (2008), 119–158.CrossRefGoogle Scholar
Gai, J.; Yao, C.; and Ye, M.. “The Externalities of High Frequency Trading.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2066839 (2013).Google Scholar
Glosten, L., and Milgrom, P. R.. “Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders.” Journal of Financial Economics, 14 (1985), 71–100.CrossRefGoogle Scholar
Hatheway, F.; Kwan, A.; and Zheng, H.. “An Empirical Analysis of Market Segmentation on U.S. Equity Markets.” Journal of Financial and Quantitative Analysis, 52 (2017), 2399–2427.CrossRefGoogle Scholar
Jovanovic, B., and Menkveld, A. J.. “Middlemen in Limit Order Markets.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1624329 (2015).Google Scholar
Latza, T.; Marsh, I. W.; and Payne, R.. “Fast Aggressive Trading.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=%202542184 (2014).CrossRefGoogle Scholar
Malinova, K., and Park, A.. “Subsidizing Liquidity: The Impact of Make/Take Fees on Market Quality.” Journal of Finance, 70 (2015), 509–536.CrossRefGoogle Scholar
Malinova, K., and Park, A.. “Does High Frequency Trading Add Noise to Prices?” Working Paper, University of Toronto (2016).Google Scholar
Menkveld, A. J.“The Economics of High-Frequency Trading: Taking Stock.” Annual Review of Financial Economics, 8 (2016), 1–24.CrossRefGoogle Scholar
Menkveld, A. J.; Yueshen, B. Z.; and Zhu, H.. “Shades of Darkness: A Pecking Order of Trading Venues.” Journal of Financial Economics, 124 (2017), 503–534.CrossRefGoogle Scholar
Menkveld, A. J., and Zoican, M. A.. “Need for Speed? Exchange Latency and Liquidity.” Review of Financial Studies, 30 (2017), 1188–1228.CrossRefGoogle Scholar
Milgrom, P., and Stokey, N.. “Information, Trade and Common Knowledge.” Journal of Economic Theory, 26 (1982), 17–27.CrossRefGoogle Scholar
O’Hara, M.“High Frequency Market Microstructure.” Journal of Financial Economics, 116 (2015), 257–270.CrossRefGoogle Scholar
O’Hara, M., and Ye, M.. “Is Market Fragmentation Harming Market Quality?” Journal of Financial Economics, 100 (2011), 459–474.CrossRefGoogle Scholar
Pagnotta, E. S., and Philippon, T.. “Competing on Speed.” Econometrica, 86 (2018), 1067–1115.CrossRefGoogle Scholar
Rojcek, J., and Ziegler, A.. “High-Frequency Trading in Limit Order Markets: Equilibrium Impact and Regulation.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2624639 (2016).CrossRefGoogle Scholar
Shkilko, A., and Sokolov, K.. “Every Cloud Has a Silver Lining: Fast Trading, Microwave Connectivity and Trading Costs.” Journal of Finance, forthcoming (2020).Google Scholar
Subrahmanyam, A., and Zheng, H.. “Limit Order Placement by High-Frequency Traders.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2688418 (2015).CrossRefGoogle Scholar
Wah, E., and Wellman, M. P.. “Latency Arbitrage, Market Fragmentation, and Efficiency: A Two-Market Model.” In Proceedings of the Fourteenth ACM Conference on Electronic Commerce, New York, NY: Association for Computing Machinery (2013), 855–872.CrossRefGoogle Scholar
Zhu, H.“Do Dark Pools Harm Price Discovery?” Review of Financial Studies, 27 (2014), 747–789.CrossRefGoogle Scholar
Supplementary material: File

Brolley and Cimon supplementary material

Brolley and Cimon supplementary material

Download Brolley and Cimon supplementary material(File)
File 228.1 KB