Authors: Mario Bellia, Loriana Pelizzon, M. Subrahmanyam, Junko Uno, Darya Yuferova

Citations: 9

Published: Unknown

Abstract

We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to market quality, defined by price discovery and liquidity provision, in the opening auction. We use a unique dataset from the Tokyo Stock Exchange (TSE) based on server-IDs and find that HFTs dynamically alter their presence in different stocks and on different days. In spite of the lack of immediate execution, about one quarter of HFTs participate in the pre-opening period, and contribute significantly to market quality in the pre-opening period, the opening auction that ensues and the continuous trading period. Their contribution is largely different from that of the other HFTs during the continuous period. JEL classification: G12, G14. Key-words: High-Frequency Traders (HFTs), Pre-Opening, Opening Call Auction, Price Discovery, Liquidity provision. ∗Bellia and Pelizzon are with SAFE, Goethe University and Ca’ Foscari University of Venice. Subrahmanyam is with Leonard N. Stern School of Business, New York University. Uno is with Waseda University and Ca’ Foscari University of Venice and Yuferova is with Norwegian School of Economics (NHH). We are grateful to Jonathan Brogaard, Austin Gerig, Björn Hagströmer, Joel Hasbrouck, Frank Hatheway, Terry Hendershott, Andrei Kirilenko, Mark van Achter, anonymous high-frequency traders, and participants at the FMA European Conference 2015, the 4th International Conference on the Industrial Organization of Securities and Derivatives Markets: High Frequency Trading, the SAFE Microstructure Workshop, Goethe University, the Conference on Securities Markets Trends, Risks and Policies, CONSOB-BAFFI CAREFIN, Bocconi University, the Swiss Society for Financial Market Research SGF Conference, the Nippon Finance Association Meeting, and the CFS Conference on High Frequency Trading, for helpful suggestions. We also thank the Tokyo Stock Exchange for providing us with anonymous detailed account-level data, which formed the basis of the research reported on in this paper. Marti Subrahmanyam thanks the von Humboldt Foundation for the financial support provided by the Anneliese Maier Research Award. We also thank the Research Center SAFE, funded by the State of Hessen Initiative for Research (LOEWE), for financial support. Darya Yuferova also gratefully acknowledges the Vereniging Trustfonds Erasmus Universiteit Rotterdam for supporting her research visit to NYU Stern and is also grateful to Rotterdam School of Management, Erasmus University, where some work on this paper was carried out during her PhD studies. Global equity markets have been fundamentally altered in the past decade due to vast improvements in the speed of trading and the consequent fragmentation of market activity. Among other changes, in many markets, traditional market makers have been replaced by high-frequency traders (HFTs), operating at the level of a few milliseconds or even microseconds. This increase in trading speed allows markets to operate far beyond human capabilities, given that the average time it takes for a human to blink varies from 300 to 400 milliseconds. These technological developments have had a dramatic impact on the behavior of liquidity providers and consumers in financial markets, and have implications for price discovery. The resulting changes have led to intense debate and scrutiny from investors, market makers, exchanges, and regulators regarding the advantageous, even unfairly advantageous, status of HFTs in global markets. Regulators in many countries have been debating, and in some cases have implemented, new regulations on HFTs in recent years. A financial transaction tax has been adopted by France, Italy, and Canada. While there are many aspects of HFT activity and its impact on global equity markets, two issues come to the fore in any policy discussion on the role of HFTs. The first is whether HFTs contribute to price discovery in the sense that they improve the incorporation of new information into asset prices in terms of speed and accuracy. The second is whether they contribute to an improvement in market liquidity, which would permit market participants to enter and exit a position in an asset rapidly and at a minimal cost. These issues have to be posed in the context of the trading schedules of equity markets. Many equity markets around the world have several distinct periods during the trading day: the pre-opening period, when quotes are placed and trades may or may not occur, an opening call auction, when buy and sell orders are crossed to determine an opening price, and a continuous trading period, when normal trading activity occurs, with posted quotes, orders, and trades. These three periods have different characteristics and the extent of HFT activity may, therefore, vary across them. In this paper, we aim to investigate the HFTs’ ability to contribute to price discovery and liquidity provision in these three different periods. To our knowledge, we are the first to See Brogaard (2010), Jovanovic and Menkveld (2015), Hendershott and Riordan (2013), and Raman and Yadav (2014), for evidence of this phenomenon. See Lewis (2014) for a popular account of this perspective.