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Economic and Social Policies, PUBLICATIONS

High Frequency Trading (HFT)

The recent financial crisis and fears of further financial destabilisation have animated the debate about the benefits and dangers of High-Frequency Trading (HFT).

Foreign exchange market chart

© MC_PP / Fotolia

Supporters of High-Frequency Trading maintain that their activities add liquidity, lower costs for investors and raise volume. On the other hand critics of HFT argue that it holds back traditional traders, makes liquidity unstable and amplifies the risk of a flash crash and price volatility.

Governments and some investors are increasingly worried that, as HFT becomes dominant in the financial trading floors, it might disrupt the stability and effectiveness of the global financial markets. Therefore regulators across the world are currently examining and discussing how to impose certain limits and restrictions on HFT practices.

The Members of the European Parliament have built-in safeguards to High-Frequency Trading activities through their amendments to the Commission’s proposals on Market on Financial Instruments (MiFID) and Market Abuse legislation (MAD). 

The agreement reached at the Ecofin Council on the 17th of June 2013 has nevertheless not removed the strong concerns among regulators and other stakeholders about the risks posed by HFT. Furthermore it is feared that the proposed legislation will not give enough transparency, allow close enough supervision or prevent abuse.

This Library Keysource brings together a selection of recent academic articles and studies that analyse the positive and negative aspects of HFT. Links to documents that are available for free are provided. However, for some documents, only the reference is included.

Analysis

High Frequency Trading: Do Regulators Need to Control this Tool of Informationally Efficient Markets? Holly A. Bell.; in Policy Analysis No. 731, July 22, 2013
This article concludes that the key issues for regulators in relation to HFT is “to be careful to distinguish between inappropriate uses of a technology and the technology itself”.

High frequency trading: should technological developments be considered a potential threat to financial markets and be subject to specific regulation? / ERA Forum, June 2013, Volume 14, Issue 1, pp 69-80
Abstract: (…) The purpose of this article is to shed some light on the various factors explaining the development of high frequency trading (including the end of the concentration rule, competition and technological innovation) as well as on the pros and cons of regulatory measures which are being considered, in particular in the revision of the Market In Financial Instruments Directive (MIFID 2) and the Market Abuse Directive (MAD2).

Trading à haute fréquence: empreinte de marché et enjeux de régulation / Luc Goupil, Revue d’économie financière n°110 (2-2013)

What Do We Know About High-Frequency Trading? / Charles M. Jones, Finance and Economics, March 20, 2013
Abstract: This paper reviews recent theoretical and empirical research on high-frequency trading (HFT)

Moore’s Law versus Murphy’s Law: Algorithmic Trading and Its Discontents / Kirilenko, Andrei A.; Lo, Andrew W., Journal of Economic Perspectives, Spring 2013, v. 27, issue 2, pp. 51-72.
This article discusses the “potential threats to financial stability created or facilitated by algorithmic trading and propose “Financial Regulation 2.0,” a set of design principles for bringing the current financial regulatory framework into the Digital Age”.

High Frequency Trading and Price Discovery / Jonathan Brogaard, Terrence Hendershott, Ryan Riordan, April 22, 2013
Abstract: We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders.

Does High-Frequency Trading Enhance or Hinder Market Fairness / Michael Aitken, Douglas Cumming, Feng Zhan, Centre for the Study of Financial Regulation,  Newsletter, Issue 10, Winter 2013

High Frequency Trading – The Good, The Bad, and The Regulation / Credit Suisse, AES Analysis, Market Commentary, 5 December 2012

A Dysfunctional Role of High Frequency Trading in Electronic Markets / Jarrow, Robert A., Protter, Philip, in International Journal of Theoretical and Applied Finance, May 2012, v. 15, issue 3, pp. 1-15.
Abstract: This paper shows that high frequency trading may play a dysfunctional role in financial markets. Contrary to arbitrageurs who make financial markets more efficient by taking advantage of and thereby eliminating mispricing, high frequency traders can create a mispricing that they unknowingly exploit to the disadvantage of ordinary investors. This mispricing is generated by the collective and independent actions of high frequency traders, coordinated via the observation of a common signal.

High-Frequency Trading: should regulators do more? / Matt Prewitt, Telecom & Technology Law Review, 131, 2012

The Volume Clock: Insights into the High-Frequency Paradigm / Easley, David; Lopez de Prado, Marcos M.; O’Hara, Maureen, in Journal of Portfolio Management, Fall 2012, v. 39, issue. 1, pp. 19-29.
According to this article HFT exploits the weakness of low-frequency trading (LFT). The authors offer advice on how Low-Frequency Traders can survive and adapt in the high speed trading environment.

An Assessment of the Social Desirability of High-Frequency Trading / Satchell, Stephen E., JASSA: The Finsia Journal of Applied Finance, 2012, issue 3, pp. 7-11.
Costs and benefits of HFT are analysed in this article together with welfare issues.

The Impacts of Automation and High Frequency Trading on Market Quality / Litzenberger, Robert; Castura, Jeff; Gorelick, Richard, Annual Review of Financial Economics, 2012, v. 4, issue 1, pp. 59-98.
Abstract: Using proprietary data sets, provided by two exchanges, that identify the activity of high frequency trading firms, studies show these firms contributed directly to narrowing bid-ask spreads, increasing liquidity, and reducing intraday transitory pricing errors and intraday volatility.

High-Frequency Trading Synchronizes Prices in Financial Markets / Austin Gerig, University of Oxford – Said Business School, November 8, 2012
Abstract: High-speed computerized trading, often called “high-frequency trading” (HFT), has increased dramatically in financial markets over the last decade. In the US and Europe, it now accounts for nearly one-half of all trades. Although evidence suggests that HFT contributes to the efficiency of markets, there are concerns it also adds to market instability, especially during times of stress. Currently, it is unclear how or why HFT produces these outcomes.

Regulatory Challenges with Respect to High-Frequency-Trading / Goldsmith, Brian in Journal of International Banking Law and Regulation, Year 2012, Volume 27, Issue 1, pages 19-26

Curbing the Dangers of High-Frequency Trading / Clements, Matthew T., The Economists’ Voice, v. 9, issue 1, 2012
Abstract: High-frequency trading, as distinct from other forms of algorithmic trading, is of little or no social value. Implementation of resting rules would retain the benefits of algorithmic trading while eliminating the potential harm of high-frequency trading.

The Future of Computer Trading in Financial Markets / UK Foresight, October 2012
This document presents the following key message: “Despite commonly held negative perceptions, the available evidence indicates that high frequency trading (HFT) and algorithmic trading (AT) may have several beneficial effects on markets. However, HFT/AT may cause instabilities in financial markets in specific circumstances. This Project has shown that carefully chosen regulatory measures can help to address concerns in the shorter term. However, further work is needed to inform policies in the longer term, particularly in view of likely uncertainties and lack of data. This will be vital to support evidence-based regulation in this controversial and rapidly evolving field.”

Where is the value in high frequency trading? / Alvaro Cartea; José Penalva; Banco de España, Working Paper 1111, 2011

High-Frequency Trading: Evidence and Considerations / Gideon Saar, Centre for the Study of Financial Regulation, Winter 2011

High frequency trading: risks and regulatory responses / Jeremy Birch in Butterworths Journal of International Banking & Financial Law, B.J.I.B. & F.L. 2011, 26(9), pages 553-555
Abstract: Discusses whether the increasing success of high frequency trading in the financial markets presents increased risks, and how regulators should respond. Looks at the effect of high frequency trading on liquidity and resilience, manipulative techniques and the danger of market contagion. Reports on consultations by the European Commission and the European Securities and Markets Authority on how to regulate the market in the light of modern trading techniques.

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