A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors

Abstract

Combining data on high frequency trading (HFT) activities of a randomly selected sample of 120 stocks and data on institutional trades, I find that HFT increases the trading costs of traditional institutional investors. One standard deviation increase in the intensity of HFT activities increases institutional execution shortfall costs by a third. Further analysis suggests that HFT represents as an ephemeral and extra-expensive source of liquidity provision when demand and supply among institutional investors are imbalanced, and that the impact on institutional trading costs is most pronounced when high frequency (HF) traders engage in directional strategies (e.g., front-running).I perform various analyses to rule out an alternative explanation that HF traders are attracted to stocks that have high trading costs. First, HFT is most active on liquid stocks. Second, the results are robust to the controls for stable stock liquidity characteristics and events that might jointly affect HFT and trading costs. Third, an analysis of the HFT behavior around the temporary short selling ban in September 2008 highlights the opportunistic nature of liquidity provision by HF traders. Finally, Granger causality tests show that intensive HFT activity significantly contributes to institutional trading costs, but not vice versa.

Order anticipation around predictable trades

“…6 They cannot find any clear evidence of a change in trading costs during these latency upgrades. In a closely related study to Brogaard et al (2014a), Tong (2015) presents evidence that institutional trading costs are higher as the HFT activity increases using the Abel Noser and NASDAQ HFT data sets. Tong (2015) also analyzes the relationship at the stockday or parent-order level due to the unavailability of the child-order data.…”

High‐Frequency Trading around Large Institutional Orders

“…Next, Tong () relates the average implementation shortfall to high‐frequency trading intensity for a U.S. equity sample. The author averages across all institutional investors in the Abel/Noser data set and documents that high shortfall days coincide with days of high HFT intensity, both for HFT “market‐making” and HFT “directional trading.” The benefit of our data set is that it has intraday time stamps (as opposed to daily time stamps) and identifies HFTs by name (as opposed to an exchange‐labeled category).…”

Automated liquidity provision

“…Brogaard et al (2013) study the effects of high-frequency trading activity on institutional investor execution costs on the London Stock Exchange from November 2007 to August 2010 and find no evidence of a relationship between the two. In contrast, Tong (2013) finds that high-frequency trading activity increases the transaction costs of institutional investors.…”