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The High-Frequency Trading Arms Race: Frequent

By Batch Auctions, Market Design, Response Eric Budish, Peter Cramton and John Shim


We propose frequent batch auctions – uniform-price double auctions conducted at frequent but discrete time intervals, e.g., every 1 second – as a market design response to the high-frequency trading arms race. Our argument has four parts. First, we use millisecond-level direct-feed data from exchanges to show that, under the continuous limit order book market design that is currently predominant, market correlations that function properly at human-scale time horizons completely break down at highfrequency time horizons. Second, we show that this correlation breakdown creates purely technical arbitrage opportunities, which in turn creates an arms race to exploit such opportunities. Third, we develop a simple theory model motivated by these empirical facts. The model shows that the arms race is not only per se wasteful, but also leads to wider spreads and thinner markets for fundamental investors. Last, we use the model to show that batching eliminates the arms race, both because it reduces the value of tiny speed advantages and because it transforms competition on speed into competition on price. Consequently, frequent batch auctions lead to narrower spreads

Year: 2013
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