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Need for Speed? Exchange Latency and Liquidity

Albert J. Menkveld¹; Marius Zoican²

¹ VU University Amsterdam and Tinbergen Institute Amsterdam · ² Université Paris Dauphine

A faster exchange does not necessarily improve liquidity. On the one hand, speed enables a high-frequency market maker (HFM) to update quotes faster on incoming news. This reduces payoff risk and thus lowers the competitive bid-ask spread. On the other hand, HFM price quotes are more likely to meet speculative high-frequency bandits, and thus are less likely to meet liquidity traders. This raises the spread. The net effect of exchange speed depends on a security's news-to-liquidity-trader ratio.

DOI

10.1093/rfs/hhx006

Volume

30 (4)

Pages

1188-1228

Language

en

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