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Highly frequent volatility

Highly frequent volatility

Source: University of Stockholm

Björn Hagströmer and Lars Norden of the University of Stockholm examine the impact of high frequency trading on market quality.

The regulatory debate concerning high frequency trading (HFT) emphasises the importance of distinguishing different HFT strategies and their influence on market quality.

Using unique data from Nasdaq OMX Stockholm, Hagströmer and Norden empirically provide such a distinction for equity markets. Comparing the behaviour of market making HFTs to opportunistic HFTs (arbitrage and momentum HFT strategies), they find that market makers constitute the lion share of HFT trading volume (63-72%) and limit order traffic (81-86%). Furthermore, market makers have higher order-to-trade ratios, lower latency, lower inventory, and supply liquidity more often than opportunistic HFTs.

In a natural experiment based on tick size changes, the study finds that both market making and opportunistic HFT strategies mitigate intraday price volatility.

The findings indicate that, for example, the financial transaction tax proposed by the European Commission, which would render most HFT strategies unprofitable, would primarily hit market makers and increase market volatility.

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