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Front‐Running and Market Quality: An Evolutionary Perspective on High Frequency Trading
Author(s) -
Hens Thorsten,
Lensberg Terje,
SchenkHoppé Klaus Reiner
Publication year - 2018
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/irfi.12159
Subject(s) - high frequency trading , speculation , profitability index , portfolio , quality (philosophy) , front (military) , business , order (exchange) , investment (military) , economics , financial economics , monetary economics , finance , algorithmic trading , engineering , mechanical engineering , philosophy , epistemology , politics , political science , law
Abstract We study front‐running by high‐frequency traders (HFTs) in a limit order model with continuous trading. The model describes an evolutionary equilibrium of low‐frequency traders who compete in portfolio management services by offering investment styles. The introduction of front‐runners inflicts heavy losses on speculators, while leaving passive investors relatively unscathed. This encourages investment in the market portfolio and markedly reduces overall turnover. Speculative trading persists despite its lower profitability. By most measures, market quality is not affected to any significant extent by front‐running HFTs.