Need for Speed? Exchange Latency and Liquidity

A faster exchange does not necessarily improve liquidity. On the one hand, speed enables a high-frequency market maker (HFM) to update quotes faster on incoming news. This reduces payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet...

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Bibliographic Details
Published in:The Review of financial studies 2017-04, Vol.30 (4), p.1188-1228
Main Authors: Menkveld, Albert J., Zoican, Marius A.
Format: Article
Language:English
Subjects:
Asked price
Latency
Liquidity
News
Payoffs
Risk assessment
Studies
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Summary:A faster exchange does not necessarily improve liquidity. On the one hand, speed enables a high-frequency market maker (HFM) to update quotes faster on incoming news. This reduces payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet speculative high-frequency bandits, and thus are less likely to meet liquidity traders. This raises the spread. The net effect of exchange speed depends on a security's news-to-liquidity-trader ratio.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhx006