Seminar

Middlemen in Limit-Order Markets

Albert J. Menkveld (VU University Amsterdam)

November 19, 2012, 12:30–14:00

Room MF 323

Fédération des Banques Françaises Seminar

Abstract

A limit-order market enables an early seller to trade with a late buyer by leaving a price quote. But, public news in the interarrival period creates adverse selection for the seller and therefore hampers trade. Machines, operated by high-frequency traders (HFTs), might restore trade by bringing the capacity to quickly update quotes on news. A theoretical model shows that HFT entry can indeed increase welfare, but it might also reduce it. Empirically, HFT entry coincided with a 23% drop in adverse-selection cost on price quotes and a 17% increase in trade frequency. Model calibration reveals a modest welfare increase.