Shackled High Speed Traders? Latency Reduction and Short Sale Bans

We explore the effects of two juxtaposed events – regulatory short sale bans and exchange efforts to facilitate high-frequency trading (HFT) – on multiple dimensions of market quality. Between 2011 and 2013, the Spanish Stock Exchange (SSE) launched a smart trading platform (SIBE-Smart) and introduced colocation facilities to attract HFT. During this time two short sale bans were imposed on the SSE. Comparing the time before and after these events, we find that the SSE’s efforts did not attract increased HFT, either with the SIBE-Smart or with colocation. Liquidity and price efficiency declined. Colocation, implemented during the second ban, was accompanied by an across the board deterioration in market quality. Strikingly, SIBE-Smart, which was not introduced during but preceded a ban, also brought significant liquidity and price efficiency reduction. These results are in contrast to existing studies that show increased HFT resulting from technological inducements. We conclude that the beneficial effects of HFT on liquidity and price efficiency are negated in the presence of regulatory restrictions on trading. JEL Classification: G14, L10