This is an SEC staff review of current working papers and published research pertaining to high frequency trading (HFT). The review addresses definitions and factual characteristics of HFT, as well as the relation between HFT and market quality. It includes a variety of questions about the studies, such as the nature and relevance of the results to the staff’s evaluation of policy issues.
This paper reviews several theoretical and empirical studies on HFT and its impact on market quality. Jones found that, “HFT and automated, competing markets improve market liquidity, reduce trading costs, and make stock prices more efficient. Better liquidity lowers the cost of equity capital for firms, which is an important positive for the real economy.” Furthermore, he noted that historically, that when “there has been a market structure change that results in more HFT, liquidity and overall market quality have improved.”
This study examines many measures of market quality and how they have changed over time and in response to regulatory and structural changes in the U.S. equity markets. Drawing from a diverse set of data sources, they show that there has been significant improvement in virtually all aspects of market quality: “execution speeds have fallen, which greatly facilitates monitoring execution quality by retail investors. Retail commissions have fallen substantially and continue to fall. Bid-‐ask spreads have fallen substantially and remain low, although they spiked upward during the financial crisis as volatility increased. Market depth has marched steadily upward. Studies of institutional transactions costs continue to find U.S. costs among the lowest in the world.”
Market Efficiency and Microstructure Evolution in US Equity Markets: A High Frequency Perspective (October 2010, and March 2012 Update)
This study examined trends in a number of U.S. equity market quality metrics in a four year period from January 2006 through June 2010. The authors considered how these metrics differed by market capitalization and by listing venue. They presented data that confirmed that over this period, quoted bid-ask spreads declined, quoted market depth increased and short‐term measures of market efficiency significantly improved. The updated Research Note examined the same metrics through the end of 2011, a period that included significant macro‐volatility surrounding the European debt crisis and U.S. credit downgrade. The data demonstrated that trends toward improving market quality continued in later periods, despite the macro-economic shocks.