Toxic Arbitrage

Foucault, Thierry; Kozhan, Roman; Tham, Wing Wah

doi:10.2139/ssrn.2409054

Cited by 38 publications

(48 citation statements)

References 51 publications

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“…Adverse selection on news is also part of Budish, Cramton, and Shim (2013) who focus on technology investments by high-frequency traders. Foucault, Kozhan, and Tham (2014) use it to study "toxic arbitrage." The paper's main result is that lowering exchange latency (i.e., increasing speed) reduces liquidity.…”

Section: Introductionmentioning

confidence: 99%

Need for Speed? Exchange Latency and Liquidity

Menkveld

Zoican

2017

The Review of Financial Studies

158

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. (0)10 408 9031 Duisenberg school of finance is a collaboration of the Dutch financial sector and universities, with the ambition to support innovative research and offer top quality academic education in core areas of finance. Terms of use: Documents in Need for Speed? Exchange Latency and Liquidity AbstractSpeeding up the exchange does not necessarily improve liquidity. The price quotes of high-frequency market makers are more likely to meet speculative high-frequency "bandits," thus less likely to meet liquidity traders. The bid-ask spread is raised in response. The recursive dynamic model reveals that there is an additional spread-widening effect as market makers earn higher rents due to economies of scope from quote monitoring. Analysis of a NASDAQ-OMX speed upgrade provides supportive evidence.

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Section: Introductionmentioning

confidence: 99%

Need for Speed? Exchange Latency and Liquidity

Menkveld

Zoican

2017

The Review of Financial Studies

158

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“…Mainland investors are concerned that when prices at the SEHK change before prices adjust on the SSE, informed foreign investors may race to the SSE to do cross‐market arbitrage through northbound trading. Although cross‐market arbitrage keeps the prices in different markets from diverging without bound, increased cross‐market arbitrage activities dampen market liquidity by increasing quoted spreads and investor trading costs (Biais, Foucault, and Moinas 2015; Foucault 1999; Foucault, Kozhan, and Tham 2017; Glosten and Milgrom 1985; Hasbrouck 2018; Zhang 2010).…”

Section: Resultsmentioning

confidence: 99%

“…The second hypothesis relates to the adverse selection channel. When the market is open to more sophisticated foreign investors, we expect to see more cross‐market arbitrage activities that increase adverse selection and speed arbitrage, therefore putting upward pressure on spreads (Biais, Foucault, and Moinas 2015; Foucault 1999; Foucault, Kozhan, and Tham 2017; Glosten and Milgrom 1985). Cross‐market arbitrage is the practice of exploiting disparities in the price at which equivalent goods can be traded in different markets.…”

Section: Hypotheses Developmentmentioning

confidence: 99%

“…These arbitrage opportunities impose a cost on liquidity provision because stale quotes can be picked off by faster high‐frequency arbitragers. Theory predicts that more cross‐market arbitrage activities increase adverse selection (adverse selection channel), therefore putting upward pressure on spread, short‐term volatility, and price impact (Biais, Foucault, and Moinas 2015; Budish, Cramton, and Shim 2015; Foucault, Kozhan, and Tham 2017; Glosten and Milgrom 1985; Hasbrouck 2018; Xu 2019; Zhang 2010). Hence, market liberalization has an ambiguous effect on spread, depending on which mechanism dominates.…”

Section: Introductionmentioning

confidence: 99%

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Stock Market Openness and Market Quality: Evidence From the Shanghai–hong Kong Stock Connect Program

Zheng

Pan

et al. 2020

J of Financial Research

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We study the impact of capital market openness on high-frequency market quality in China. The Shanghai-Hong Kong Stock Connect program (SHHKConnect) opens China's stock market to foreign investors and offers a natural experiment to investigate this question. Using a difference-in-differences approach, we find that market liberalization leads to lower quoted spread, lower effective spread, lower market depth, and higher short-term volatility. Our findings imply that opening the markets to more sophisticated foreign investors is associated with higher competition and more cross-market arbitrage activities, narrowing the spread and reducing liquidity providers' profits, but increasing the price impact and short-term volatility of connected stocks.

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“…Additional work suggests a link between HFT and increased volatility (Arnuk and Saluzzi, 2012). Foucault et al (2015) examine latency arbitrage opportunities in currency markets, and provide evidence of a tradeoff between pricing efficiency and liquidity. In another study, Baron et al (2012) find that some kinds of HFT activities directly harm ordinary investors.…”

Section: High-frequency Trading Modelsmentioning

confidence: 99%

Latency arbitrage in fragmented markets: A strategic agent-based analysis

Wah¹,

Wellman

2017

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Abstract.We study the effect of latency arbitrage on allocative efficiency and liquidity in fragmented financial markets. We employ a simple model of latency arbitrage in which a single security is traded on two exchanges, with price quotes available to regular traders only after some delay. An infinitely fast arbitrageur reaps profits when the two markets diverge due to this latency in cross-market communication. Using an agent-based approach, we simulate interactions between high-frequency and zero-intelligence trading agents. From simulation data over a large space of strategy combinations, we estimate game models and compute strategic equilibria in a variety of market environments. We then evaluate allocative efficiency and market liquidity in equilibrium, and we find that market fragmentation and the presence of a latency arbitrageur reduces total surplus and negatively impacts liquidity. By replacing continuous-time markets with periodic call markets, we eliminate latency arbitrage opportunities and achieve further efficiency gains through the aggregation of orders over short time periods.

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Toxic Arbitrage

Cited by 38 publications

References 51 publications

Need for Speed? Exchange Latency and Liquidity

Need for Speed? Exchange Latency and Liquidity

Stock Market Openness and Market Quality: Evidence From the Shanghai–hong Kong Stock Connect Program

Latency arbitrage in fragmented markets: A strategic agent-based analysis

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