High Frequency Trading Review



    Recently exchanges have been supplementing their tape revenue by directly selling trade and quote data to some traders. We analyze how this practice affects the cost of capital, market liquidity and welfare by studying a two-period economy in which rational traders can purchase information about past transactions from the exchanges. In an economy in which traders are endowed with private signals about asset value, allowing the exchange to sell price data increases the cost of capital and worsens market liquidity relative to a world in which all traders freely observe previous prices. However, selling price data reduces the cost of capital and increases liquidity relative to an economy in which no traders can observe price information. If traders have to decide whether to purchase private signals, as well as whether to purchase price data, selling price data can cause traders to reduce their effort to gather information on the underlying asset. This secondary effect may increase the equilibrium cost of capital, but paradoxically it results in greater liquidity. Our welfare analysis also shows that as more previous price information is present in the market, noise traders are made better-off and speculative rational traders are made worse-off. In our view, allowing exchanges to sell price information is undesirable because it generally reduces efficiency and market quality. We believe that the practice should be restricted.

    Easley, David, O’Hara, Maureen and Yang, Liyan, Differential Access to Price Information in Financial Markets (March 15, 2011). Johnson School Research Paper Series No. 11-2011. Available at SSRN: http://ssrn.com/abstract=1787029 or http://dx.doi.org/10.2139/ssrn.1787029

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