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On the surface, bid-ask spreads are far more narrow than even several years ago.

However, during periods of financial stress liquidity seems to vanish. Also, the increasing amount of fragmentation (i.e. new exchanges, crossing markets / dark pools, etc.) is moving markets away from deep central pools of liquidity. Combined with ultra-HFT linkages across markets there seems to be a potential for increased systemic risk via contagion. There also seem to be glitches -- such as today's 9% flash crash in Apple based on a 100-share trade. There's also research that at the micro-structure level price changes are now exhibiting non-normality (where previously this was observed only at lower frequencies).

The evidence seems mixed and anecdotal. How does this net out? Is there are any hard research on the effects of HFT on market depth, liquidity, and volatility during peacetime and periods of stress?

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Tal asked a question about HFT last year that generated a list of articles: Has high frequency trading (HFT) been a net benefit or cost to society? –  chrisaycock Mar 23 '12 at 19:06
Yep - I looked at that. That asks net benefits to society. This is more specific as to effects on the market but thanks for the pointer. –  Quant Guy Mar 23 '12 at 19:29
HFT helps speed up the convergency process. –  user2204 Mar 24 '12 at 4:13

3 Answers 3

up vote 7 down vote accepted

Joel Hasbrouck (imho, a leading expert in market microstructure) has a paper on this:


From the abstract:

Our conclusion is that increased low-latency activity improves traditional market quality measures such as short-term volatility, spreads, and displayed depth in the limit order book.

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Thanks! Funny how all these papers seem to be contradict each other. –  Quant Guy Mar 23 '12 at 21:31
It does not exactly contradict the other papers, it all depends of the measure used and if you test for liquidity during stress periods. –  BlueTrin Nov 2 '12 at 14:14

A race to zero by Andrew Haldane, Bank of England has some interesting content and references to research regarding this.

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Interesting paper and well written. Seems to contradict the Joel Hasbrouck paper. –  Quant Guy Mar 23 '12 at 21:32

I have been coming across a few of these research lately.

I don't have access to it anymore but I remember reading the abstract of this article, but it's really outdated now.

After a quick look, I found this paper which is much more recent (2011) as well as this one (2010).

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What do these papers say? Can you summarize them here? –  chrisaycock Mar 23 '12 at 19:04
AS I said in the post, I can't access them anymore... I'll try to see if I've got something in my notes... –  SRKX Mar 24 '12 at 1:06

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