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High frequency trading and price discovery

Author

Listed:
  • Brogaard, Jonathan
  • Hendershott, Terrence
  • Riordan, Ryan
Abstract
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. JEL Classification: G12

Suggested Citation

  • Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2013. "High frequency trading and price discovery," Working Paper Series 1602, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20131602
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    high frequency trading; price discovery; price formation; pricing errors;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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    This paper has been announced in the following NEP Reports:

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