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Feb 24 2015
Bank of England Studies Market Impact of High-Frequency Trading
Reprinted with permission from Traders Magazine

Score one for high-frequency traders. 

The much-maligned trading group just got a vote of approval from the Bank of England courtesy of a new study which said HFT doesn't contribute to price distortions and have a deleterious effect on the U.K equities market. It does not comment on HFT's effects on the U.S. equities market.

Read the complete paper here:

The study, Number 469 titled "High-frequency trading behaviour and its impact on market quality: evidence from the UK equity market" was written by Evangelos Benos and Satchit Sagade.

According to the paper, the research was undertaken to analyze the intraday behavior of high-frequency traders (HFTs) and its impact on aspects of market quality such as liquidity, price discovery and excess volatility. For that, the study used a unique transactions data set for four UK stocks, over the period of a randomly selected week. Our data identifies the counterparties to each transaction, enabling us to track the trading behavior of individual HFTs.

"We first find that HFTs differ significantly from each other in terms of liquidity provision: while some HFTs mostly consume liquidity (ie trade more 'aggressively') by primarily executing trades via market orders," the authors began. "Others mostly supply liquidity (ie trade more 'passively') by primarily executing trades via limit orders.'

To examine how trading behavior is related to these patterns of liquidity provision, the authors split the HFTs in two groups, according to their trade aggressiveness, and examined the behavior and impact of each group separately. The study found that the 'passive' HFTs follow a trading strategy consistent with market making and as such their trades have alternating signs and are independent of recent (ten-second) price changes.

By contrast, 'aggressive' HFTs exhibit persistence in the direction of their trades and trade in line with the recent (ten-second) price trend.

"We find that both higher price volatility and lower spreads cause HFT activity to increase. We suggest a number of reasons as to why this might be so," the study said.

Finally, the study used a tick time specification to examine the impact of HFT activity on price discovery (ie information-based volatility) and noise (ie excess volatility). It found that while HFTs have a higher information-to-noise contribution ratio than non-HFTs, there are instances where this is accompanied by a large absolute noise contribution.

For original version, please click here.

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