High-Frequency Trading and its Impact on Market Liquidity: A Review of Literature

Year 2021, Volume: 5 Issue: 1, 345 - 368, 26.01.2021

Oğuz Ersan , Nihan Dalgıç , Cumhur Enis Ekinci , Mehmet Bodur

https://doi.org/10.29023/alanyaakademik.799039

Cited By: 1

Abstract

High-frequency trading (HFT) has been dominating the activity in developed financial markets in the last two decades. Despite its recent formation, the literature on the impacts of HFT on financial markets and participants is broad. However, there are ongoing debates and unanswered questions within many subtopics. We survey through the research towards HFT effects on liquidity in an attempt to explain the coexistence of evidence regarding both the positive and the negative impacts of HFT. We name two main factors leading to mixed results. Former concerns the negative market conditions such as intraday shocks, through which HFT trading patterns may sharply change. Latter regards the certain characteristics of HFT liquidity provision with the potential to present externalities for the market.

Keywords

High-frequency trading, HFT, Liquidity, Intraday shocks, Extreme price movements

Supporting Institution

TÜBİTAK

Project Number

218K566

References

• AKYILDIRIM, E., ALTAROVICI, A., & EKİNCİ, C. (2015). “Effects of Firm-Specific Public Announcements on Market Dynamics: Implications for High-Frequency Traders”. Handbook of High Frequency Trading, Academic Press (Elsevier).
• AMMAR, I. B., HELLARA, S., & GHADHAB, I. (2020). “High-frequency trading and stock liquidity: An intraday analysis”. Research in International Business and Finance, 101235.
• ANAND, A., & VENKATARAMAN, K. (2016). “Market conditions, fragility, and the economics of market making”. Journal of Financial Economics, 121(2), 327-349.
• AÏT-SAHALIA, Y., & SAGLAM, M. (2013). ”High frequency traders: Taking advantage of speed (No. w19531)”. National Bureau of Economic Research.
• AÏT-SAHALIA, Y., & SAGLAM, M. (2017). “High frequency market making: Implications for liquidity”. Available at SSRN 2908438. ANAGNOSTIDIS, P., & FONTAINE, P. (2020). “Liquidity commonality and high frequency trading: Evidence from the French stock market”. International Review of Financial Analysis, 69, 101428.
• BALDAUF, M., & MOLLNER, J. (2020). “High‐Frequency Trading and Market Performance”. The Journal of Finance, 75(3), 1495-1526.
• BAZZANA, F., & COLLINI, A. (2020). “How does HFT activity impact market volatility and the bid-ask spread after an exogenous shock? An empirical analysis on S&P 500 ETF”. The North American Journal of Economics and Finance, 54, 101240.
• BENOS, E., BRUGLER, J., HJALMARSSON, E., & ZIKES, F. (2017). “Interactions among high-frequency traders”. Journal of Financial and Quantitative Analysis, 52(4), 1375-1402.
• BERNALES, A. (2019). “Make-take decisions under high-frequency trading competition”. Journal of Financial Markets, 45, 1-18. BERTRAND, M., DUFLO, E., & MULLAINATHAN, S. (2004). “How much should we trust differences-in-differences estimates?”. The Quarterly Journal of Economics, 119(1), 249-275.
• BHATTACHARYA, N., CHAKRABARTY, B., & WANG, F.X. (2017). “Do High Frequency Traders Bring Fundamental Information into Prices?”. Working Paper, Saint Louis University and Singapore Management University.
• BLOCHTER, J., COOPER, R., SEDDON, J., & VAN VLIET, B. (2016). “Phantom liquidity and high-frequency quoting”. The Journal of Trading, 11(3), 6-15.
• BOEHMER, E., JONES, C.M., & ZHANG, X. (2013). “Shackling short sellers: The 2008 shorting ban”. The Review of Financial Studies, 26(6), 1363-1400.
• BOEHMER, E., LI, D., & SAAR, G. (2018). “The competitive landscape of high-frequency trading firms”. The Review of Financial Studies, 31(6), 2227-2276.
• BRECKENFELDER, J. (2019). “Competition among high-frequency traders, and market quality”.
• BROGAARD, J. (2010). “High frequency trading and its impact on market quality”. Northwestern University Kellogg School of Management Working Paper, 66.
• BROGAARD, J., HENDERSHOTT, T., & RIORDAN, R. (2014). “High-frequency trading and price discovery”. The Review of Financial Studies, 27(8), 2267-2306.
• BROGAARD, J., HENDERSHOTT, T., & RIORDAN, R. (2017). “High frequency trading and the 2008 short-sale ban”. Journal of Financial Economics, 124(1), 22-42.
• BROGAARD, J., CARRION, A., MOYAERT, T., RIORDAN, R., SHKILKO, A., & SOKOLOV, K. (2018). “High frequency trading and extreme price movements”. Journal of Financial Economics, 128(2), 253-265.
• BROGAARD, J., & GARRIOTT, C. (2019). “High-frequency trading competition”. Journal of Financial and Quantitative Analysis, 54(4), 1469-1497.
• BUDISH, E., CRAMTON, P., & SHIM, J. (2015). “The high-frequency trading arms race: Frequent batch auctions as a market design response”. The Quarterly Journal of Economics, 130(4), 1547-1621.
• CALCAGNILE, L. M., BORMETTI, G., TRECCANI, M., MARMI, S., & LILLO, F. (2018). “Collective synchronization and high frequency systemic instabilities in financial markets”. Quantitative Finance, 18(2), 237-247.
• CARRION, A. (2013). “Very fast money: High-frequency trading on NASDAQ”. Journal of Financial Markets, 16(4), 680-711.
• CARTEA, Á., & PENALVA, J. (2012). “Where is the value in high frequency trading?”. The Quarterly Journal of Finance, 2(03), 1250014.
• CESPA, G., & FOUCAULT, T. (2014). ”Illiquidity contagion and liquidity crashes”. The Review of Financial Studies, 27(6), 1615-1660.
• CHABOUD, A.P., CHIQUOINE, B., HJALMARSSON, E., & VEGA, C. (2014). “Rise of the machines: Algorithmic trading in the foreign exchange market”. The Journal of Finance, 69(5), 2045-2084.
• CHORDIA, T., GREEN, T. C., & KOTTIMUKKALUR, B. (2018). “Rent seeking by low-latency traders: Evidence from trading on macroeconomic announcements”. The Review of Financial Studies, 31(12), 4650-4687.
• CHUNG, K.H., & LEE, A.J. (2016). “High-frequency trading: Review of the literature and regulatory initiatives around the world”. Asia-Pacific Journal of Financial Studies, 45(1), 7-33.
• CLAPHAM, B., HAFERKORN, M., & ZIMMERMANN, K. (2019, May). “Does Speed Matter? The Role of High-Frequency Trading for Order Book Resiliency”. In The Role of High-Frequency Trading for Order Book Resiliency (May 9, 2019). Paris December 2015 Finance Meeting EUROFIDAI-AFFI.
• CONRAD, J., & WAHAL, S. (2020). “The term structure of liquidity provision”. Journal of Financial Economics, 136(1), 239-259.
• CONRAD, J., WAHAL, S., & XIANG, J. (2015). “High-frequency quoting, trading, and the efficiency of prices”. Journal of Financial Economics, 116(2), 271-291.
• DEGRYSE, H., DE WINNE, R., GRESSE, C., & PAYNE, R. (2019). “Cross-Venue Liquidity Provision: High Frequency Trading and Ghost Liquidity”.
• EASLEY, D., DE PRADO, M. M. L., & O’HARA, M. (2011). “The microstructure of the “flash crash”: flow toxicity, liquidity crashes, and the probability of informed trading”. The Journal of Portfolio Management, 37(2), 118-128.
• EASLEY, D., DE PRADO, M. M. L., & O’HARA, M. (2012). “Flow toxicity and liquidity in a high-frequency world”. The Review of Financial Studies, 25(5), 1457-1493.
• EGGINTON, J. F., VAN NESS, B. F., & VAN NESS, R. A. (2016). “Quote stuffing”. Financial Management, 45(3), 583-608.
• EKİNCİ, C., AKYILDIRIM, E., & CORBET, S. (2019). “Analysing the dynamic influence of US macroeconomic news releases on Turkish stock markets”. Finance Research Letters, Vol 31, 155-164.
• EKİNCİ, C., & ERSAN, O. (2018). “A New Approach for Detecting High-Frequency Trading from Order and Trade Data”. Finance Research Letters, Vol 24, 313-320.
• EKİNCİ, C., & ERSAN, O. (2020). “High-Frequency Trading and Market Quality: case of a Slightly Exposed Market”. Working Paper.
• ERSAN, O., & EKİNCİ, C. (2016). “Level of Algorithmic and High-frequency Trading in Borsa Istanbul”. Borsa Istanbul Review, 16(4), 233-248.
• FOUCAULT, T., HOMBERT, J., & ROSU, I. (2016). “News Trading and Speed”. The Journal of Finance, 71(1), 335-382.
• FOUCAULT, T., KOZHAN, R., & THAM, W.W. (2017). “Toxic arbitrage”. The Review of Financial Studies, 30(4), 1053-1094.
• GOLDSTEIN, M.A., KUMAR, P., & GRAVES, F.C. (2014). “Computerized and high-frequency trading”. Financial Review, 49(2), 177-202.
• GOLUB, A., KEANE, J., & POON, S. H. (2012). “High frequency trading and mini flash crashes”. Available at SSRN 2182097.
• GRANT, J. (2010). “High-frequency trading: Up against a bandsaw”. Financial Times (September 02, 2010).
• HAGSTRÖMER, B., & NORDÉN, L. (2013). “The diversity of high-frequency traders”. Journal of Financial Markets, 16(4), 741-770.
• HALDANE, A. G. (2010). “Patience and finance”. Speech to Oxford China business forum. Beijing: Bank of England.
• HASBROUCK, J., & SAAR, G. (2013). “Low-latency trading”. Journal of Financial Markets, 16(4), 646-679.
• HAUTSCH, N., NOÉ, M., & ZHANG, S. S. (2017). “The ambivalent role of high-frequency trading in turbulent market periods”.
• HOFFMANN, P. (2014). “A dynamic limit order market with fast and slow traders”. Journal of Financial Economics, 113(1), 156-169.
• JAIN, P. K., JAIN, P., & MCINISH, T. H. (2016). “Does high-frequency trading increase systemic risk?”. Journal of Financial Markets, 31, 1-24.
• JARNECIC, E., & SNAPE, M. (2014). “The provision of liquidity by high‐frequency participants”. Financial Review, 49(2), 371-394.
• JIANG, G. J., LO, I., & VALENTE, G. (2014). “High-frequency trading around macroeconomic news announcements: Evidence from the US treasury market”. (No. 2014-56). Bank of Canada Working Paper.
• JOHNSON, N., ZHAO, G., HUNSADER, E., QI, H., JOHNSON, N., MENG, J., & TIVNAN, B. (2013). “Abrupt rise of new machine ecology beyond human response time”. Scientific reports, 3, 2627.
• JONES, C.M. (2013). “What do we know about high-frequency trading?”. Columbia Business School Research Paper, (13-11).
• JØRGENSEN, K., SKJELTORP, J., & ØDEGAARD, B.A. (2018). “Throttling hyperactive robots-Order-to-trade ratios at the Oslo Stock Exchange”. Journal of Financial Markets, 37, 1-16.
• KANG, J., KWON, K. Y., & KIM, W. (2020). “Flow toxicity of high‐frequency trading and its impact on price volatility: Evidence from the KOSPI 200 futures market”. Journal of Futures Markets, 40(2), 164-191.
• KE, Y., & ZHANG, Y. (2019). “Does high-frequency trading reduce market underreaction to earnings news?”. Finance Research Letters.
• KIRILENKO, A., KYLE, A. S., SAMADI, M., & TUZUN, T. (2017). “The flash crash: High‐frequency trading in an electronic market”. The Journal of Finance, 72(3), 967-998.
• KORAJCZYK, R.A., & MURPHY, D. (2019). “High-frequency market making to large institutional trades”. The Review of Financial Studies, 32(3), 1034-1067.
• LEAL, S. J., NAPOLETANO, M., ROVENTINI, A., & FAGIOLO, G. (2016). “Rock around the clock: An agent-based model of low-and high-frequency trading”. Journal of Evolutionary Economics, 26(1), 49-76.
• LEAL, S. J., & NAPOLETANO, M. (2019). “Market stability vs. market resilience: Regulatory policies experiments in an agent-based model with low-and high-frequency trading”. Journal of Economic Behavior & Organization, 157, 15-41.
• LEE, E. J. (2015). “High frequency trading in the Korean index futures market”. Journal of Futures Markets, 35(1), 31-51.
• LI, K., COOPER, R., & VAN VLIET, B. (2018). “How does high-frequency trading affect low-frequency trading?”. Journal of Behavioral Finance, 19(2), 235-248.
• MADHAVAN, A. (2012). “Exchange-traded funds, market structure, and the flash crash”. Financial Analysts Journal, 68(4), 20-35.
• MALCENIECE, L., MALCENIEKS, K., & PUTNIŅŠ, T. J. (2019). “High frequency trading and comovement in financial markets”. Journal of Financial Economics, 134(2), 381-399.
• MALINOVA, K., PARK, A., & RIORDAN, R. (2013). “Do retail traders suffer from high frequency traders?”. Available at SSRN, 2183806.
• MCINISH, T., UPSON, J., & WOOD, R. A. (2014). “The flash crash: Trading aggressiveness, liquidity supply, and the impact of intermarket sweep orders”. Financial Review, 49(3), 481-509.
• MENKVELD, A. J. (2013). “High frequency trading and the new market makers”. Journal of financial Markets, 16(4), 712-740.
• MENKVELD, A. J., & ZOICAN, M. A. (2017). “Need for speed? Exchange latency and liquidity”. The Review of Financial Studies, 30(4), 1188-1228.
• MILLER, R.S., & SHORTER, G. (2016). “High frequency trading: Overview of recent developments”. U.S. Congressional Research Service, 7-5700.
• NAWN, S., & BANERJEE, A. (2019). “Do proprietary algorithmic traders withdraw liquidity during market stress?”. Financial Management, 48(2), 641-676.
• O’HARA, M. (2015). “High frequency market microstructure”. Journal of Financial Economics, 116(2), 257-270.
• O’HARA, M., SAAR, G., & ZHONG, Z. (2019). “Relative tick size and the trading environment”. The Review of Asset Pricing Studies, 9(1), 47-90.
• ORIOL, N., & VERYZHENKO, I. (2019). “Market structure or traders’ behavior? A multi agent model to assess flash crash phenomena and their regulation”. Quantitative Finance, 19(7), 1075-1092.
• PADDRIK, M., HAYES, R., TODD, A., YANG, S., BELING, P., & SCHERER, W. (2012, March). “An agent based model of the E-Mini S&P 500 applied to Flash Crash analysis”. In 2012 IEEE Conference on Computational Intelligence for Financial Engineering & Economics (CIFEr) (pp. 1-8). IEEE.
• PATELL, J. M., & WOLFSON, M. A. (1984). “The intraday speed of adjustment of stock prices to earnings and dividend announcements”. Journal of Financial Economics, 13(2), 223-252.
• POPPER, N. (2012). “High-speed trading no longer hurtling forward”. New York Times (October 14, 2012).
• PREWITT, M. (2012). “High-frequency trading: Should regulators do more”. Michigan Telecommunications and Technology Law Review, 19, 131.
• SCHOLTUS, M., VAN DIJK, D., & FRIJNS, B. (2014). “Speed, algorithmic trading, and market quality around macroeconomic news announcements”. Journal of Banking & Finance, 38, 89-105.
• SPROTHEN (2016). “Trading tech accelerates toward speed of light”. The Wall Street Journal. Retrieved from https://www.fnlondon.com/articles/trading-technology-accelerates-toward-speed-of-light-20160808 (01.07.2020).
• STIGLITZ, J.E. (2014). “Tapping the brakes: Are less active markets safer and better for the economy?”. U.S. SECURITIES and EXCHANGE COMMISSION. (2010). “Part III: Concept release on equity market structure; Proposed Rule, 17 CFR Part 242”. Federal Register, 75(13), 3594-3614.
• VAN KERVEL, V. (2015). “Competition for order flow with fast and slow traders”. The Review of Financial Studies, 28(7), 2094-2127.
• VIRGILIO, G.P.M. (2019). “High-frequency trading: a literature review”. Financial Markets and Portfolio Management, 33(2), 183-208.
• YE, M., YAO, C., & GAI, J. (2013). “The externalities of high frequency trading”. WBS Finance Group Research Paper, 180.
• ZHAO, Y., & WAN, D. (2018). “Institutional high frequency trading and price discovery: Evidence from an emerging commodity futures market”. Journal of Futures Markets, 38(2), 243-270.