High-frequency trading and institutional trading costs

Abstract

Using bond futures data, we test whether high-frequency trading (HFT) is engaging in back running, a trading strategy that can create costs for financial institutions. We reject the hypothesis of back running and find instead that HFT mildly improves trading costs for institutions. After a rapid increase in the number of HFTs, trading costs as measured by implementation shortfall decrease by 27 basis points for smaller-sized positions ($2-$10 million notional). For larger-sized positions there is no significant effect. We explain the improvement as being the consequence of HFT reducing effective spreads and pertrade price impacts.

Broker Colocation and the Execution Costs of Customer and Proprietary Orders

“…She also observes that this effect is alleviated for some institutional investors with high levels of trading skills, as measured by historical transaction costs, though her data do not allow her to explore the determinants of institutional trading skills. Chen and Garriott (2020) find that HFT in the Canadian bond futures market leads to lower institutional execution costs for relatively small parent orders. Finally, Brogaard, Hendershott, Hunt, and Ysusi (2014) do not find any causal effect of HFT on institutional transaction costs on the London Stock Exchange.…”

Adverse selection in cryptocurrency markets

“…Cryptocurrency markets are order‐driven markets without designated market makers, but liquidity is typically supplied by voluntary market makers who follow the same principles as designated market makers. For most asset classes traded as limit order book markets, the market making is now dominated by high‐frequency traders (Chen & Garriott, 2020; Nawn & Banerjee, 2019). To that end, inventory costs can also be significant determinants of overall liquidity.…”