High Frequency Trading and Price Discovery (European Central Bank)

November 2013

KEYWORDS: High-Frequency Trading, HFT, price discovery, market efficiency, Volatility, Liquidity, Macro


Jonathan Brogaard, Terrence Hendershott, Ryan Riordan

  • European Central Bank

We examine empirically the role of high-frequency traders (HFTs) in price discovery and price efficiency. Based on our methodology, we find overall that HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.

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