High Frequency Trading Literature Review September 2013 This brief literature review presents a summary of recent empirical studies related to automated or “high frequency trading” (HFT) and its impact on various markets. Each study takes a unique approach, yet all paint a consistent picture of markets being improved by competition and automation. Author(s) / Title Dataset Findings Angel, Harris, Spatt U.S. equities, 1993 – 2009 Trading costs have declined, bid-ask spreads have "Equity trading in the 21st narrowed and available century", February 2010 liquidity has increased June 2013 (Update) Castura, Litzenberger, U.S. equities, 2006-2011 Bid-ask spreads have Gorelick (RGM Advisors) narrowed, available liquidity has increased and “Market Efficiency and price efficiency has Microstructure Evolution in improved US Equity Markets: A High Frequency Perspective”, October 2010, and March 2012 (Update) Avramovic (Credit Suisse) U.S. equities, 2003-2010 Bid-ask spreads have narrowed, available “Sizing Up US Equity liquidity has increased, and Microstructure”, April 2010 short-term volatility “Who Let the Bots Out? (normalized by longer term Market Quality in a High U.S. equities, 2004-2011 volatility) has declined; the Frequency World”, March incidence of “mini” crashes 2012 has not increased Hasbrouck, Saar U.S. equities, full NASDAQ Low latency automated order book trading was associated with "Low-Latency Trading", July lower quoted and effective 2012 June 2007 and October 2008 spreads, lower volatility and greater liquidity Cumming, Zhan, Aitken 22 international equities Increasing HFT activity was markets, identifying the found to be the most robust “High Frequency Trading availability of colocation as a and significant predictor of and End-Of-Day proxy for HFT activity a reduction in end-of-day Manipulation”, January 2013 market manipulation 1 Weisberger, Rosa (2 Sigma) U.S. equities and CBOE VIX No evidence that volatility data has increased due to recent “Automated equity trading: market structure changes The evolution of market structure and its effect on volatility and liquidity”, June 2013 Bollen, Whaley 15 futures contracts on 4 Volatility attributable to leading futures exchanges structural factors did not “Futures Market Volatility: change in most of these What has Changed?”, August contracts over long time 2013 periods, suggesting HFT and automated trading have not impacted volatility Jones Various U.S. equities data Reviews empirical evidence sets and finds HFT acts to “What do we know about “improve market liquidity, high frequency trading?”, reduce trading costs, and March 2013 make stock prices more efficient” Hendershott, Riordan Automated vs. other trades. Automated trades made prices more efficient and “Algorithmic Trading and Deutsche Börse equities, did not contribute to higher Information”, August 2009 January 2008 volatility Chaboud, Hjalmarsson, Vega Automated vs. other trades. Automated trades increased and Chiquoine liquidity and may have EBS forex market, 2006- lowered volatility “Rise of the Machines: 2007 Debelle (Markets Committee, Various FX venues, notably HFT is beneficial during Bank for International Reuters and EBS, and various normal market periods, Settlements) dates, notably May 6, 2010 with similar behavior to and March 17, 2011 traditional market “High-frequency trading in participants during high the foreign exchange volatility periods market”, September 2011 Brogaard, Hendershott, HFT vs. other trades. U.S. HFT was positively Riordan equities on NASDAQ, various correlated with permanent periods in 2008 – 2010 price changes and “High Frequency Trading and negatively correlated with Price Discovery”, July 2012 transitory price changes, suggesting that HFT improves price discovery 2 Hirschey, Nicholas HFT vs. other trades. U.S. HFT was positively equities on NASDAQ, various correlated with non-HFT, “Do High-Frequency Traders periods in 2008 – 2010 corroborating Brogaard, Anticipate Buying and Selling Hendershott and Riordan Pressure?”, December 2011 results O’Hara, Yao, Ye HFT vs. other trades. U.S. Odd-lots and trades of 100 equities on NASDAQ, various shares drove the majority of What’s Not There: The Odd- periods in 2008 – 2010 price discovery; HFT was Lot Bias in TAQ Data, July more likely to trade with 2011 odd-lots Gerig HFT vs. other trades. U.S. “HFT facilitates information equities on NASDAQ, transfer between investors, “High-Frequency Trading February 2010, plus which increases the accuracy Synchronizes Prices in Thompson Reuters data from of prices and redistributes Financial Markets”, November 2000, 2005, and 2010 profits from informed 2012 individuals to average investors by reducing transaction costs“ Jarnecic, Snape HFT vs. other trades HFT improved liquidity and was unlikely to have “An analysis of trades by high LSE equities, April – June, increased volatility frequency participants on the 2009 London Stock Exchange”, June 2010 Su, Aldinger, Labuszewski Automated vs. other trades. Automated trading was (CME Group) associated with improved CME futures, May 2008 – liquidity and reduced "Algorithmic trading and May 2010 volatility market dynamics", July 2010 Kirilenko, Kyle, Samadi and CME E-mini S&P-500 equities HFT traders did not change Tuzun index futures contract, their behavior during the May 3 - May 6, 2010 flash crash; HFT were net “The Flash Crash: The Impact buyers during the crash, net of High Frequency Trading on sellers during the recovery; an Electronic Market”, May HFT may have induced more 2011 trading during the crash 3 Backes (Eurex AG) Eurex FDAX: DAX equities During “FDAX flash crash”, index futures contract HFT acted “in a way that “High-frequency trading in August 25, 2011 protects the market by volatile markets - an placing a rapid succession of examination”, October 2011 small, non-directional buy and sell orders, thus preventing abrupt price movements”, improving market quality during a period of high stress Menkveld Dutch equities traded on Chi- A single high frequency X and Euronext, 2007 trader played an important “High Frequency Trading role in the development of a and the New-Market competitive market center, Makers”, February 2012 resulting in better liquidity and lower trading costs Lepone HFT vs. other trades. HFT has become a major Singapore Exchange (SGX), provider of liquidity, “The Impact of High Australia Securities particularly during periods Frequency Trading (HFT): Exchange (ASX), NASDAQ of market uncertainty International Evidence”, and London Stock Exchange September 2011 Frino, Lepone and Mistry Australia Securities Exchange Algorithmic trading grew (ASX), October 2006 - October from 35% to 55% of dollar “The New Breed of Market 2009 volume and was a net Participants: Algorithmic liquidity supplier. Trading on the ASX”, March Algorithmic trading rates 2012 increased when spreads were wide, volatility low, volumes low and depth low Frino and Lepone LSE and Euronext trade HFT was found, data, Jan 2006 - Dec 2011 statistically, to drive end of “The impact of high day prices away from frequency trading on dislocations. Additionally, market integrity: an HFT was found to not have empirical examination”, a statistically significant May 2012 relationship with ‘Ticking”, a proxy of short-term price manipulation Hagströmer and Nordén NASDAQ OMX Stockholm HFT market making, stat-arb Equities market and momentum strategies all “The diversity of high August 2011, February 2012 mitigate intraday price frequency traders”, volatility September 2012 4 Baron, Brogaard, and Audit trail of CME ES HFTs were profitable, using Kirilenko contract, August 2010 to a 1 minute measure of August 2012 profitability, and earned “The Trading Profits of High profits trading with all Frequency Traders”, classes of counterparties, up November 2012 to 1 bp. Profitability was consistent over the period Benos and Sagade, (Bank of Full audit-trail data for four HFTs exhibited substantial England) UK stocks in a randomly variability in strategies. chosen week in between “Passive” appeared like “High-frequency trading 2011-2012 traditional market making, behavior and its impact on while “aggressive” tended market quality: evidence to trade in direction of from the UK equity market”, recent price moves. Both December 2012 were more active when prices were volatile and spreads, narrow. HFT had a higher information-to-noise ratio than non-HFT Malinova, Park, Riordan Canadian Equities data “HFTs appear to not impose negative externalities on the “Do Retail Traders Suffer least sophisticated market from High Frequency participants and … may be Traders?”, May 2013 beneficial to slower and less sophisticated traders” Hendershott, Jones, Automated quoting facility, Automated trading Menkveld NYSE equities, 2003 narrowed bid-ask spreads, lowered trading costs, and “Does Algorithmic Trading improved price efficiency Improve Liquidity?”, February 2012 Riordan, Storkenmaier Xetra high-speed trading Higher system speeds led to system, Deutsche Börse, increased liquidity and “Latency, Liquidity and Price 2007 improved price discovery Discovery”, November 2011 Hendershott, Moulton NYSE TAQ database plus Introduction of automation others, June 1, 2006 - May via the NYSE hybrid system “Automation, Speed and 31, 2007 improved price discovery Stock Market Quality: The NYSE’s Hybrid”, February 2010 5 Brogaard, Hendershott, Technology upgrade events Higher system speeds Hunt, Latza, Pedace and on the LSE, between 2008 - correlated with increased Ysusi (UK FSA) 2010 HFT in two of four