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Eric Budish, Chicago Booth Print
Tuesday, 21 May 2013, 14:00 - 15:15

Eric Budish, Chicago Booth

The High Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response


Abstract: We propose frequent batch auctions – uniform-price double auctions conducted e.g. every 1 second – as a market design response to the high-frequency trading arms race. Our argument has four parts. First, we document a phenomenon we call correlation breakdown: under the continuous-time limit-order book that is currently predominant in financial markets, market correlations that function properly at human-scale time horizons break down at high-frequency time horizons. Second, we show that this correlation breakdown creates purely technical arbitrage opportunities, which in turn create an arms race to exploit such opportunities. Third, we develop a simple theory model motivated by these empirical facts. The model shows that the HFT 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 frequent batch auctions mitigate the arms race, narrow spreads and improve market depth. We also suggest that frequent batch auctions have benefits for market stability.

Location: R42.2.113
Contact: Claude Adan, This e-mail address is being protected from spam bots, you need JavaScript enabled to view it