Quantifying the High-Frequency Trading “Arms Race”

We use stock exchange message data to quantify the negative aspect of high-frequency trading, known as “latency arbitrage.” The key difference between message data and widely familiar limit order book data is that message data contain attempts to trade or cancel that fail. This allows the researcher to observe both winners and losers in a race, whereas in limit order book data you cannot see the losers, so you cannot directly see the races. We find that latency arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5–10 millionths of a second), and account for a remarkably large portion of overall trading volume (about 20%). Race participation is concentrated, with the top six firms accounting for over 80% of all race wins and losses. The average race is worth just a small amount (about half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market’s cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

Order-Flow Segmentation, Liquidity, and Price Discovery: The Role of Latency Delays

Latency delays intentionally slow order execution at an exchange, often to protect market makers against latency arbitrage. We study informed trading in a fragmented market in which one exchange introduces a latency delay on market orders. Liquidity improves at the delayed exchange as informed investors emigrate to the conventional exchange, where liquidity worsens. In aggregate, implementing a latency delay worsens total expected welfare. We find that the impact on price discovery depends on the relative abundance of speculators. If the exchange with delay technology competes against a conventional exchange, it implements a delay only if it has sufficiently low market share.

The FX Race to Zero

This chapter traces how technological changes have affected the structure and operation of currency markets, and examines the issues associated with these developments. These changes have caused significant concern within the industry and raise complicated questions about whether additional regulation is necessary. Nevertheless, they have received relatively little theoretical or empirical attention in comparison to similar developments in equities markets. To address this gap, the chapter outlines the primary market structural issues in foreign exchange markets, including potentially abusive trading techniques, last look, and perverse incentives to monetize access to speed and information. Further, the chapter provides an example of a high frequency latency arbitrage opportunity and discusses the potential mitigating impact of a randomized delay mechanism. This is followed by an analysis of recent regulatory efforts to address these issues in the UK, the EU, and the US, in addition to a review of industry-led initiatives to establish best practices for algorithmic traders and venue operators. The chapter concludes by discussing key questions and constraints for future research.