High-Frequency Trading and Price Discovery

We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days...

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Bibliographic Details
Published in:The Review of financial studies 2014-08, Vol.27 (8), p.2267-2306
Main Authors: Brogaard, Jonathan, Hendershott, Terrence, Riordan, Ryan
Format: Article
Language:English
Subjects:
Adverse selection
Coefficients
Electronic trading systems
High frequency trading
Liquidity
Macroeconomics
Market prices
Nasdaq Composite Index
Order flow
Price efficiency
Price level changes
Price volatility
Prices
Pricing
Studies
Supply
Trade
Traders
Volatility
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Summary:We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs' liquidity supplying orders are adversely selected. The direction of HFTs' trading predicts price changes over short horizons measured in seconds. The direction of HFTs' trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhu032