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We use stock exchange message data to quantify the negative aspect of high-frequency trading, known as “latency arbitrage.” The key difference between message data and widely familiar limit order book data is that message data contain attempts to trade or cancel that fail. This allows the researcher to observe both winners and losers in a race, whereas in limit order book data you cannot see the losers, so you cannot directly see the races. We find that latency arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5–10 millionths of a second), and account for a remarkably large portion of overall trading volume (about 20%). Race participation is concentrated, with the top six firms accounting for over 80% of all race wins and losses. The average race is worth just a small amount (about half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market’s cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

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Matching algorithms are important for well‐functioning financial markets. This paper examines the 2007 change by LIFFE, to move from pure pro‐rata to time pro‐rata allocation for the Euribor, Short Sterling, and Euroswiss futures contracts. We show that the removal of pure pro‐rata matching reduces market depth but suggest that this outcome improves execution quality for market participants. Our results are consistent with suggestions in the literature that the former regime creates incentives for traders to “drown” the order book with large orders and that the addition of a time element to this algorithm alters their behavior. We provide evidence that traders increase the amount of order splitting in the new framework, consistent with local optimizing, but argue that this may hinder overall market efficiency. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 35:522–541, 2015