High-frequency trading accounts for roughly half of US stock transactions, and the industry, which can involve roof lasers or strategically-located data centers, is shrinking as its profits “have collapsed”. But we finally have some actual data on how it affects markets. A new paper by Johannes Breckenfelder claims to be “the first empirical evidence on the competition between high-frequency traders (HFTs) and its influence on market quality.”
Breckenfelder looked at the Swedish market and found that if there’s only one HFT shop trading a given stock, then HFT improves liquidity in that stock. But when a second HFT firm joins in, and the algorithms start competing against each other for trades, volatility goes up and liquidity goes down.
HFT’s champions cite increased liquidity as one of the of benefits trading at high speeds. But late last year, the Treasury Department’s Office of Financial Research found that HFT may “obscure price discovery, exaggerate illiquidity, increase volatility and contribute to extreme price changes.”
To Matt O’Brien, “liquidity is the last refuge of bullshitters”, and HFT is something akin to cheating, particularly if firms are paying to get early access to market data. “It's a tax on everybody else. And it's a tax that has basically no benefit,” he writes. Themis Trading has a long list of research on the negative sides of the HFT industry here. There’s much more -- plus GIFs, if you’re into that sort of thing -- at Nanex, a market data firm. Nanex claims firms in Chicago and New York got advanced notice of Fed data in October, and the “resulting explosion of trading just 1 thousandth of a second after 2pm, was unprecedented in the history of Fed news announcements.”
In October, Felix wrote that HFT’s benefits were considerable before the financial crisis -- as technology advanced, algobots made for cheaper, more automatic trades for the wider public. But after blowups like the Flash Crash, that value, he wrote, morphed into risk. Stock market volumes, for one, have fallen, as algobots have gotten “so sophisticated at sparring with each other that they’re not even trading with each other any more.”
Noah Smith says it’s not quite clear that we should crack down on HFT firms based on Breckenfelder’s findings, which, he says, don’t speak to how the practice affects price efficiency, or how it may impact corporate finance. In fact, he suggests that the attrition of a algobot-vs-algobot war may turn high-frequency trading into “a small, self-limiting phenomenon”. -- Ryan McCarthy
On to today’s links:
UGH
How is it possible that the world is unprepared for rising rates -- again? - Eduardo Porter
Must Read
This is how American families go hungry - Ned Resnikoff
Servicey
How to succeed: 1) don't be nice 2) be irrationally overconfident 3) be a narcissist 4) be a psychopath - Chris Dillow
Distinctions
College is only worth it if you finish - AEI
Remuneration
Socialism in America (or, living wages) - Ingrid Robeyns
There's a shortage of pilots because the pay starts at $21,000 - Bloomberg Businessweek
Alpha
John Maynard Keynes, fund manager - NYT
Takedowns
Superfoods are dumb and they ruin a good meal - Jay Rayner
Good Luck With That
3 problems Congress should stop asking the Fed to solve - Fortune
Amazing
Hieronymus Bosch’s "600-years-old butt song from hell" - Chaos Controlled 123
Emerging Markets
How Turkey's prime minister lost the battle for low interest rates - Piotr Zalewski
Wonks
Short-term unemployment is the best predictor of wage growth - Liberty Street Economics
Good Questions
How do people survive when their unemployment benefits run out? - Ylan Mui
Tactless
Goldman handed out nail files and mirrors at a Harvard women's coding event - William Alden
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