Abstract:
This paper studies the impact of changes in high frequency trading on market quality. On April 1st, 2012 the Investment Industry Regulatory Organization of Canada starting charging its members an (initially unknown) cost recovery fee per exchange message (e.g., orders, trades, cancellations, etc). Following the introduction of the fee, high frequency traders (HFT) reduce their market activity significantly, both in absolute terms and as a percentage of market activity. Using the fee change as an exogenous instrument, we employ order-level data to estimate the causal effect of HFT activities on market quality and on the costs of other traders, in particular of retail traders. Post event, HFTs generate fewer messages overall and particularly in smaller, less liquid stocks. The reduction of HFT message traffic causes an increase in spreads and an increase in the trading costs of retail and other traders, or, put differently, HFT activities generate a positive externality and lower other market participants’ trading costs.

Malinova, Katya, Park, Andreas and Riordan, Ryan, Do Retail Traders Suffer from High Frequency Traders? (November 15, 2012). Available at SSRN: http://ssrn.com/abstract=2183806 or http://dx.doi.org/10.2139/ssrn.2183806

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