High Frequency Trading and Fragility
50 Pages Posted: 15 Feb 2017
There are 4 versions of this paper
High Frequency Trading and Fragility
Market Transparency and Fragility
High Frequency Trading and Fragility
High Frequency Trading and Fragility
Date Written: February 10, 2017
Abstract
We show that limited dealer participation in the market, coupled with an informational friction resulting from high frequency trading, can induce demand for liquidity to be upward sloping and strategic complementarities in traders' liquidity consumption decisions traders demand more liquidity when the market becomes less liquid, which in turn makes the market more illiquid, fostering the initial demand hike. This can generate market instability, where an initial dearth of liquidity degenerates into a liquidity rout (as in a flash crash). While in a transparent market, liquidity is increasing in the proportion of high frequency traders, in an opaque market strategic complementarities can make liquidity U-shaped in this proportion as well as in the degree of transparency.
Keywords: market fragmentation, high frequency trading, ash crash, asymmetric information
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation