Every Cloud Has a Silver Lining: Fast Trading, Microwave Connectivity, and Trading Costs

Abstract

Modern markets are characterized by speed differentials, with some traders being fractions of a second faster than others. Theoretical models suggest that such differentials may have both positive and negative effects on liquidity and gains from trade. We examine these effects by studying a series of exogenous weather episodes that temporarily remove the speed advantages of the fastest traders by disrupting their microwave networks. The disruptions are associated with lower adverse selection and lower trading costs. In additional analysis, we show that the long-term removal of speed differentials results in similar effects and also increases gains from trade. COMPETITION ON RELATIVE SPEED IS A DEFINING characteristic of modern markets where trading firms invest heavily to gain a speed advantage over their rivals. The race to acquire the fastest technology often leads to subsecond speed differentials among traders. A rich theoretical literature suggests that such differentials may have opposing effects on liquidity and gains from

Contagious margin calls: How COVID-19 threatened global stock market liquidity

“…For reasons outlined in Section 4, HFMMs are likely to be more margin sensitive due to their unique trading style, which focuses on trading across short time horizons and using leveraged derivatives to hedge price risk. Similarly, Brogaard et al (2014) and Shkilko and Sokolov (2020) show that high-frequency traders are more prevalent in index stocks, which is also supported by our empirical tests in Subsection 6.3. Thus, because HFMMs are more likely to withdraw their liquidity from stocks in which they are most active, we expect larger liquidity declines for index stocks, relative to non-index stocks, when margin increases.…”

“…We argue that HFMMs are more sensitive to margin requirements than traditional traders due to their unique trading style. HFMMs operate over short time horizons, and typically carry no overnight inventory risk ( Hasbrouck and Saar, 2013 , Bartlett and McCrary, 2019 , Shkilko and Sokolov, 2020 ). Accordingly, their positions are unlikely to precipitate a margin call, as large adverse price moves are unlikely to occur during their short holding periods.…”

“…We argue that high-frequency market makers (HFMMs), who are heavily reliant on leverage for liquidity provision, are more sensitive to margin requirements than traditional investors, and thus, more likely to withdraw from the market following large increases in margin requirements. Further, HFMMs are more likely to be present in index stocks, relative to non-index stocks, which have lower HFMM participation ( Brogaard et al, 2014 , Shkilko and Sokolov, 2020 ). Because of these factors, as margin requirements increase, we expect a larger decline in the liquidity of index stocks in which HFMM are more active, relative to non-index stocks.…”

Order Routing Decisions for a Fragmented Market: A Review

“…argues that increased number of faster traders could result in more order cancellations in a relatively high-latency venue, creating frictions and harming slow traders. Shkilko and Sokolov (2020) show that the differential in a traders' trading speed harms market quality.…”

Effect of high‐frequency trading on mutual fund performance

“…Some academic researchers find that HFT reduces trading costs for most market participants (Brogaard & Garriott, 2019; Baldauf & Mollner, 2020; Boehmer, Fong, & Wu, 2021; Conrad, Wahal, & Xiang, 2015; Goldstein, Kumar, & Graves, 2014; Hendershott, Jones, & Menkveld, 2011; Hendershott & Riordan, 2013). On the other hand, many studies suggest that HFT may increase the trading costs of traditional institutional investors by anticipating their trades (Biais, Foucault, & Moinas, 2015; Bongaerts & Van Achter, 2021; Hirschey, 2021; Korajczyk & Murphy, 2019; Shkilko & Sokolov, 2020; Van Kervel & Menkveld, 2019; Yang & Zhu, 2020). A similar lack of agreement exists among practitioners, and some of them have taken actions to protect themselves from HFT.…”