Financial Econometrics and Empirical Market Microstructure

Raising Issues About Impact of High Frequency Trading on Market Liquidity

Vladimir Naumenko

Abstract The aim of this paper is to consider some problems with evaluation of the impact of high frequency trading on market liquidity. The first part is devoted to difficulties of disentangling the impact of high frequency on market liquidity from other relevant factors. The remainder of the paper is intended to discuss some issues affecting the evaluation of the influence of high frequency trading on particular aspects of market liquidity.

Keywords Depth • High frequency trading • Market liquidity • Resiliency • Tightness

Over the last years, high-frequency trading (HFT) has become the object of ever - increasing attention on the part of market participants and academics as well as regulators. Plenty of academic studies were devoted to evaluating the impact of HFT on different aspects of market quality such as liquidity, volatility, and informational efficiency. It is not surprising that they have different, and sometimes diametrically opposed views about HFT’s impact on modern financial markets. Despite the fact that the opinions of experts in the field of financial markets split, the general background of statements in mass media concerning HFT can be characterized as negative. In addition, a number of initiatives were proposed by regulators all over the world in response to changes in the nature of trading in financial instruments, largely due to the prevalence of HFT (IOSCO 2011). These proposals also require serious consideration, since their implementation in some cases can lead to far-reaching consequences for the market quality, while not always clear and definite in advance.

The importance of thorough examination of the matter is confirmed by evidences that a significant increase in number of trades and quotes attributable to HFT has occurred over the past 5-10 years in many trading venues. Despite the stabilization or even a slight decrease in the proportion of HFT in developed capital markets, there is no doubt that in the near future the impact of this phenomenon on the

V. Naumenko (H)

JSC “PROGNOZ”, Risk Lab, Perm, Russia

National Research University Higher School of Economics, FERM Lab, Moscow, Russia e-mail: naumenko. v@prognoz. ru

© Springer International Publishing Switzerland 2015

A. K. Bera et al. (eds.), Financial Econometrics and Empirical Market

Microstructure, DOI 10.1007/978-3-319-09946-0_____ 14 market quality will continue to remain significant. In any case, despite the decline in market share of HFT, there is no serious rationale to believe that HFT for any reason will voluntary quit the markets in the coming years, albeit under the above mentioned negative pressure from the mass media and scrutiny from the regulators. Moreover, in the less developed trading venues, especially those based in developing countries, a trend of inflow of HFT traders to markets remains (WFE2013). In these circumstances, it is of great importance to study the behavior of trading algorithms and other things necessary to elaborate procedures in order to encourage positive behavior and eliminate or at least mitigate possible negative effects.