Time Pro‐rata Matching: Evidence of a Change in LIFFE STIR Futures

Abstract

Matching algorithms are important for well‐functioning financial markets. This paper examines the 2007 change by LIFFE, to move from pure pro‐rata to time pro‐rata allocation for the Euribor, Short Sterling, and Euroswiss futures contracts. We show that the removal of pure pro‐rata matching reduces market depth but suggest that this outcome improves execution quality for market participants. Our results are consistent with suggestions in the literature that the former regime creates incentives for traders to “drown” the order book with large orders and that the addition of a time element to this algorithm alters their behavior. We provide evidence that traders increase the amount of order splitting in the new framework, consistent with local optimizing, but argue that this may hinder overall market efficiency. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 35:522–541, 2015

High‐frequency trading: Definition, implications, and controversies

“…Since spoofing works within the outlined criteria, it should not be prohibited. Aspris et al (2015) examine the effect of switching the matching algorithms adopted by the London International Financial Futures Exchange in 2007 for order submission strategies. The event involved the introduction of a "time pro rata" matching algorithm to replace the older "pure pro rata" mechanism.…”

“…The mechanics of the former matching algorithm are found to incentivize traders to flood the order book with a much larger quantity than they truly intend to execute, a situation comparable to the spoofing and layering problems. Following the microstructure change, Aspris et al (2015) find significant changes in market participant behavior, evidenced by the sizeable decline in market depth, as well as a substantial increase in the numbers of small order entries and cancellations. The new matching mechanism is found to eliminate "false liquidity" from the market, thus, giving the participants a more reliable representation of the actual liquidity level in the market.…”

“…Following the microstructure change, Aspris et al. (2015) find significant changes in market participant behavior, evidenced by the sizeable decline in market depth, as well as a substantial increase in the numbers of small order entries and cancellations. The new matching mechanism is found to eliminate “false liquidity” from the market, thus, giving the participants a more reliable representation of the actual liquidity level in the market.…”

Size Precedence and Share Volume: The Case of the PSX Exchange

“…Thus, the cumulative quoted volume at the best price is relatively large. Also, in analysis of the shift by LIFFE from a pure pro-rata matching algorithm to a time pro-rata algorithm, Aspris et al (2015)¯nd that market participants change their order submission strategies and depth decreases substantially.…”

Market Manipulation as a Security Problem

“…In our previous scenario, with two buy orders A (for 200 shares) and B (50 shares) at the same price, an incoming sell order for 200 shares will be matched with 160 shares from A and 40 shares from B (i.e., 80% of each). In other words, if the offer does not suffice to cover the demand, all orders will be filled partially [12,27]. Besides this basic version of the pro-rata algorithm, there are several other variants with additional constraints such as maximum volume caps and minimum volume thresholds.…”