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Experiments in high-frequency trading: comparing two market institutions

Published online by Cambridge University Press:  14 March 2025

Eric M. Aldrich  and
Kristian López Vargas
Eric M. Aldrich*
Affiliation:
Department of Economics, University of California, Santa Cruz, USA
Kristian López Vargas*
Affiliation:
Department of Economics, University of California, Santa Cruz, USA
*
[email protected]
[email protected]
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Abstract

We implement a laboratory financial market where traders can access costly technology that reduces communication latency with a remote exchange. In this environment, we conduct a market design study on high-frequency trading: we contrast the performance of the newly proposed frequent batch auction (FBA) against the continuous double auction (CDA), which organizes trades in most exchanges worldwide. Our evidence suggests that, relative to the CDA, the FBA exhibits (1) less predatory trading behavior, (2) lower investments in low-latency communication technology, (3) lower transaction costs, and (4) lower volatility in market spreads and liquidity. We also find that transitory shocks in the environment have substantially greater impact on market dynamics in the CDA than in the FBA.

Keywords

Market designAuctionsHigh-frequency tradingContinuous double auctionFrequent batch auction

JEL classification

D53: Financial Markets D44: Auctions D47: Market Design G12: Asset Pricing • Trading Volume • Bond Interest Rates C91: Laboratory, Individual Behavior G14: Information and Market Efficiency • Event Studies • Insider Trading
Type
Original Paper
Information
Experimental Economics , Volume 23 , Issue 2 , June 2020 , pp. 322 - 352
Copyright
Copyright © 2019 Economic Science Association

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Footnotes

Electronic supplementary material The online version of this article (https://doi.org/10.1007/s10683-019-09605-2) contains supplementary material, which is available to authorized users.

This project received funding from the Center for Analytical Finance (CAFIN) at the University of California, Santa Cruz and from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme (Grant Agreement No. 741409). This paper is part of a larger, joint project with Dan Friedman, Axel Ockenfels, Peter Cramton. We thank them for invaluable feedback and Darrel Hoy and David Malec for developing the remote exchanges. We thank conference and seminar audiences at: the 2016 SEF meeting in Tucson, the 2017 SEF meeting in Nice (in particular, Jürgen Huber, Peter Bossaerts and Stefan Palan), the 2017 ESA meeting in Richmond, ICESI University, the UCSC-Econ brown bag seminar, the 2018 CAFIN HFT workshop (in particular, Pete Kyle). We also thank Morgan Grant, Jason Vranek and Daniel Thurau for excellent programming work at the UCSC LEEPS Laboratory. The results reflect the authors’ view—the ERC is not responsible for any use that may be made of the information it contains.

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