Who provides liquidity, and when?

Sida Li, Xin Wang, Mao Ye

Research output: Contribution to journalArticlepeer-review

Abstract

We model competition for liquidity provision between high-frequency traders (HFTs) and slower execution algorithms (EAs) designed to minimize investors’ transaction costs. Under continuous pricing, EAs dominate liquidity provision by using aggressive limit orders to stimulate HFTs’ market orders. Under discrete pricing, HFTs dominate liquidity provision if the bid-ask spread is binding at one tick. If the tick size (minimum price variation) is not binding, EAs choose between stimulating HFTs and providing liquidity to non-HFTs. Transaction costs increase with the tick size but can be negatively correlated with the bid-ask spread when all traders can provide liquidity.

Original languageEnglish (US)
Pages (from-to)968-980
Number of pages13
JournalJournal of Financial Economics
Volume141
Issue number3
DOIs
StatePublished - Sep 2021

Keywords

  • Algorithmic trading
  • Bid-ask spread
  • High-frequency trading
  • Liquidity
  • Tick size

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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