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A note on the relationship between high-frequency trading and latency arbitrage

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JournalInternational Review of Financial Analysis
DateAccepted/In press - 29 Jun 2016
DateE-pub ahead of print - 5 Jul 2016
DatePublished (current) - Oct 2016
Volume47
Number of pages16
Pages (from-to)281-296
Early online date5/07/16
Original languageEnglish

Abstract

We develop three artificial stock markets populated with two types of market participants — HFT scalpers and aggressive high frequency traders (HFTrs). We simulate real-life trading at the millisecond interval by applying Strongly Typed Genetic Programming (STGP) to real-time data from Cisco Systems, Intel and Microsoft. We observe that HFT scalpers are able to calculate NASDAQ NBBO (National Best Bid and Offer) at least 1.5 ms ahead of the NASDAQ SIP (Security Information Processor), resulting in a large number of latency arbitrage opportunities. We also demonstrate that market efficiency is negatively affected by the latency arbitrage activity of HFT scalpers, with no countervailing benefit in volatility or any other measured variable. To improve market quality, and eliminate the socially wasteful arms race for speed, we propose batch auctions in every 70 ms of trading.

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© 2016 Published by Elsevier Inc.This is an author-produced version of the published paper. Uploaded in accordance with the publisher’s self-archiving policy.

    Research areas

  • Agent-based modelling, Algorithmic trading, Genetic programming, High frequency trading, Market efficiency, Market regulation

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