2nd CEPR-Imperial-Plato Market Innovator (MI3) Conference 2018
Multimarket High-Frequency Trading and Commonality in Liquidity
Olga Klein (Warwick Business School)
Shiyun Song (Warwick Business School)
Olga Klein is Assistant Professor of Finance at the Warwick Business School. Olga’s research interests lie in the areas of market microstructure and market efficiency. She is especially interested in the implications of trading on efficiency of security prices and in the optimal design of financial markets.
Shiyun Song is a PhD student at the University of Warwick Business School. She was previously a visiting PhD in Boston College, and holds a MRes in Finance from Lancaster University.
About the paper
This paper from Olga and Shiyun examines the effects of multimarket high-frequency trading activity on systematic liquidity co-movements across different markets.
Multimarket trading by HFTs connects individual markets in a single network, inducing stronger network-wide liquidity co-movements. They used a staggered introduction of an alternative trading platform, Chi-X, in European equity markets as the instrument for an exogenous increase in multimarket HFT activity.
Consistent with predictions, Olga and Shiyun found that liquidity co-movements with an aggregate European market significantly increase after Chi-X introduction and even dominate liquidity co-movements with the home market.
By acting competitively and processing information more efficiently, high-frequency traders (HFTs) generally improve market quality by increasing liquidity, reducing short-term volatility and contribute to positive price discovery.
The researchers used the staggered introduction of an alternative trading platform, Chi-X, in European equity trading markets as the instrument to assess the effect of multimarket HFT activity n systematic liquidity co-movements. Since the trading of European major index stocks on Chi-X was introduced in several phases, it allows researchers to identify the casual effect of multimarket HFT.
Liquidity co-movements within aggregate European markets significantly increase after the introduction of Chi-X in any given country and are even higher than liquidity co-movements within the home market.
Market participants and policymakers are underestimating the potential liquidity risks generated by High Frequency Traders. Stronger network-wide liquidity co-movements, especially during crisis periods, imply that equity markets are now more susceptible to negative liquidity shocks, especially when such shocks are more likely to occur.