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High-Frequency Quoting: Short-Term Volatility in Bids and Offers

Published online by Cambridge University Press:  15 March 2018

Joel Hasbrouck
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Abstract

At subsecond horizons, bids and offers in U.S. equity markets are more volatile than what would be implied by long-term fundamentals. To assess costs and consequences, this paper suggests that traders’ random delays (latencies) interact with quote volatility to generate execution price risk and relative latency costs. Analysis of the behavior of quote setters suggests that this volatility is more likely to arise from recurrent cycles of undercutting similar to the Edgeworth cycles found in product markets rather than mixed strategies of limit-order placement.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 2 , April 2018 , pp. 613 - 641
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

I have benefited from the comments of an anonymous referee, Hendrik Bessembinder (the editor), Fany DeKlerck, Ramo Gençay, Dale Rosenthal, Jeffrey Russell, Gideon Saar, Mao Ye, and seminar/conference participants at Aalto University, Baruch College, BI Norwegian Business School, the Conference on Financial Econometrics (Toulouse), the Copenhagen Business School, Duke University, City University London Emerging Markets Group, the 2013 Euronext Paris Conference on High-Frequency Trading, l’Institut Louis Bachelier, Jump Trading, Norges Bank Investment Management, NYU/Stern, SAC Capital, the Society of Financial Econometrics (Toronto), the University of California at Irvine, the University of Illinois at Urbana–Champaign, the University of Illinois at Chicago, the University of Pennsylvania Econometrics Seminar, the Wharton Finance Department Seminar, and Utpal Bhattacharya’s doctoral students at the University of Indiana. All errors are my own responsibility. This research was not specifically supported or funded by any organization. During the period over which this research was developed, I taught (for compensation) in the training program of a firm that engages in high-frequency trading and served as a member (uncompensated) of a CFTC advisory committee on high-frequency trading. I am grateful to Jim Ramsey for originally introducing me to time-scale decompositions.

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