HFT helps market structure and liquidity, academic study finds

First Published 5th June 2012

Contrary to what many people may believe, high frequency trading is a positive force for markets, a new academic study from Australia finds.

"When we began this suite of research we spoke extensively to investors in many markets on their view about HFT... They were overwhelmingly negative, so when our results began to show that HFT actually had positive impacts, we were very surprised." - Alex Frino

Chicago - Capital Markets Cooperative Research Centre (CMCRC), an Australian independent academic centre for capital market research, has found that high-frequency trading (HFT) provides positive benefits for the structure and liquidity of futures markets.

"The project found that the presence of HFT adds real liquidity to futures markets, and reduces price volatility, contrary to popular suspicion," CMCRC said in a news release.

The centre had published similar findings in 2011 for a project specifically on equity markets. Directed by Professor Alex Frino, researchers applied the models that had been developed for equities to futures markets in order to examine the impact of HFT on liquidity provision and volatility.

Professor Frino said his research for other markets suggests that colocation increases greatly the amount of HFT activity, and in turn this enhances market liquidity.

"We are currently in the middle of research examining trading on futures' exchanges to document its effect on the liquidity of the major contracts traded electronically, specifically Eurodollar Futures, E-mini S&P 500 futures, 10 year T-note futures and WTI Crude oil futures," Professor Frino said.

Professor Frino's models look specifically at liquidity from 'make' and 'take' perspectives - how often a quote is hit, and how often HFTs hit existing quotes. The team found that HFTs are overall net providers of liquidity and that their liquidity is used as readily by other market participants as any other type of liquidity.

From a volatility perspective the research again mirrored findings in equity markets.

"HFTs appear to assist in decreasing excessive price volatility," Frino said. "This is partly due to the way HFT algorithms identify trading opportunities - they're built to recognise when prices are abnormally high or low, and respond in a way that naturally pushes prices back towards the middle."

Professor Frino said the results of the research remained somewhat surprising, given global sentiment towards HFT.

"Last year when we began this suite of research we spoke extensively to investors in many markets on their view about HFT," he said. "They were overwhelmingly negative, so when our results began to show that HFT actually had positive impacts, we were very surprised."

Professor Frino's next research project looks at the impact of dark liquidity on equity exchanges, with findings due for release this month.

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