False News, Informational Efficiency, and Price Reversals

Abstract

Speculators can discover whether a signal is true or false by processing it but this takes time. Hence they face a trade-off between trading fast on a signal (i.e., before processing it), at the risk of trading on false news, or trading after processing the signal, at the risk that prices already reflect their information. The number of speculators who choose to trade fast increases with news reliability and decreases with the cost of fast trading technologies. We derive testable implications for the effects of these variables on (i) the value of information, (ii) patterns in returns and trades, (iii) the frequency of price reversals in a stock, and (iv) informational efficiency. Cheaper fast trading technologies simultaneously raise informational efficiency and the frequency of "mini-flash crashes": large price movements that revert quickly.

The effect of fast trading on price discovery and efficiency: Evidence from a betting exchange

“…Slow traders may trade less or stop trading if they feel they have a systematic disadvantage, thereby impairing price discovery. Fur-thermore, HFTs may play a disfunctional role when they collectively and aggressively trade on a common signal, thereby moving prices away from their fundamentals (Jarrow & Protter, 2012;Dugast, Foucault, et al, 2014). Additionally, the informativeness of prices may decrease in the medium-term because slower investors may stop conducting fundamental research as they cannot profit from it (Foucault, Hombert, & Roşu, 2016).…”

Strategic Speed Choice by High-Frequency Traders Under Speed Bumps

“…17 Of course, the setting of the speed decision used in our model does not comprehensively reflect real-world conditions. As Dugast et al (2014) suggest, some components of speed choice may occur simultaneously with market makers' behavior. However, we believe that the ex-ante strategic speed decision is still significant because HFTs would not invest in speed ex-ante if they did not exploit it in an ex-post trading game.…”

Market Fairness: The Poor Country Cousin of Market Efficiency

“…3 For more explanation of the role of permanent and transitory shocks in the execution of trading strategies, see Chakravarty et al (2009) and the Appendix to Harris et al (2014). 4 Dugast and Foucault (2014) develop a model of price reversals as speculators trade fast on false signals and then revert back after processing the signal. enhance both fairness and efficiency or at a minimum harm neither.…”