Abstract:

Exogenous technology shocks that increase the speed of trading from microseconds to nanoseconds dramatically increase order cancellation/execution ratio from 26:1 to 32:1 but do not have real impact on liquidity, price efficiency and trading volume. We find evidence consistent with “quote stuffing:” a manipulative practice that involves submitting a large number of orders with immediate cancellation to generate congestion. The stock data are handled by six randomly grouped channels in NASDAQ, and message flow of a stock can slow down the trading of stocks in the same channel but not stocks in a different channel. We detect an abnormally high level of co-movement of message flow for stocks in the same channel through factor regression and discontinuity test. These results suggest that investment in speed at the sub-millisecond level may allow high frequency traders to play more complex trading games without a consummate social benefit.

Ye, Mao, Yao, Chen and Gai, Jiading, The Externality of High Frequency Trading (May 25, 2012). Available at SSRN: http://ssrn.com/abstract=2066839 or http://dx.doi.org/10.2139/ssrn.2066839

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