High‐Frequency Trading and the New Stock Market: Sense And Nonsense |
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| Authors: | Merritt B. Fox Lawrence R. Glosten Gabriel V. Rauterberg |
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| Affiliation: | 1. MERRITT FOX is Michael E. Patterson Professor of Law and NASDAQ Professor for the Law and Economics of Capital Markets at Columbia Law School, as well as Co‐Director of the School's Center for Law and Economics and Co‐Director of the Columbia Law School/Business School Program in the Law and Economics of Capital Markets.;2. LAWRENCE R. GLOSTEN is the S. Sloan Colt Professor of Banking and International Finance at Columbia Business School and an adjunct professor at Columbia Law School. |
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| Abstract: | The stock market has been transformed during the last 25 years. Human suppliers of liquidity like the NASDAQ dealers and NYSE specialists have been replaced by algorithmic market making; stocks that once traded on a single venue now trade across twelve exchanges and a multitude of alternative trading systems. New venues like dark pools, and new participants like high‐frequency traders, have emerged to take on prominent roles. This new market has had more than its share of controversy and regulatory scrutiny, particularly in the wake of Michael Lewis’s bestseller Flash Boys. In this article, the authors analyze five of the most controversial new market practices, including various high‐frequency trading strategies and dark pool activities. They set out a simple conceptual framework based on adverse selection and agency problems, and apply that framework to assess the welfare effects of each of the five practices. While much that is criticized is indeed objectionable, other controversial practices are much more complex than popularly imagined and may in fact be socially desirable. They conclude by evaluating a range of potential reforms to equity market structure. |
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