PrefBlog

The Bank of Canada has released a working paper by Michael Brolley, David A. Cimon titled Order Flow Segmentation, Liquidity and Price Discovery: The Role of Latency Delays:

Latency delays—known as “speed bumps”—are an intentional slowing of order flow by exchanges. Supporters contend that delays protect market makers from high-frequency arbitrage, while opponents warn that delays promote “quote fading” by market makers. We construct a model of informed trading in a fragmented market, where one market operates a conventional order book and the other imposes a latency delay on market orders. We show that informed investors migrate to the conventional exchange, widening the quoted spread, while the quoted spread narrows at the delayed exchange. The overall market quality impact depends on the relative concentration of speculators who may become informed. If speculators are few relative to liquidity traders, total welfare falls; with relatively more speculators, total welfare rises.
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Latency delays are one of the latest means by which exchanges differentiate themselves. These delays are introduced to segment uninformed order flow from the broader market, by preventing informed traders acting on fleeting information. We find that latency delays have a mixed impact on market liquidity: the imposition of a delay improves liquidity on the delayed exchange, but worsens liquidity on standard exchanges. Moreover, the presence of a delayed exchange reduces overall information acquisition, but the subsequent impact on price discovery depends on the ratio of speculators to liquidity traders: with a greater presence of speculators, a delayed exchange worsens overall price discovery, whereas markets with fewer speculators see price discovery improvements when one market imposes a delay.

Our model makes several empirical predictions. We predict that, following the introduction of a delay, quoted spreads should improve at the delayed exchange, while worsening at the standard exchanges. We also predict that the presence of a delayed exchange improves liquidity investor participation, and that informed trading should cluster on the non-delayed exchange. Finally, we predict that as adverse selection increases, total exchange volume falls, while delayed exchange volume increases.

Of interest to policy makers, the impact of delays on price discovery and welfare depend on the relative concentration of speculators. The presence of a delay either decreases welfare when there are few speculators, or increases welfare when there are many. Results for price discovery are reversed: price discovery falls when there are many speculators, but may increase if there are few. Depending on whether a regulator prioritizes welfare or price discovery, the regulator may wish to allow delays for some assets, while disallowing for others.

Equities have tanked after some Trumpian sabre rattling on trade:

President Donald Trump ordered his administration to consider imposing tariffs on an additional $100 billion in Chinese imports, a salvo that sent U.S. stock futures tumbling on concern the world’s two largest economies were hurtling toward a full-blown trade war.

The move threatens to unravel efforts by top U.S. and Chinese trade officials to lower the heat and reach an agreement that could stave off an escalating conflict.

U.S. stock futures dropped on Trump’s latest trade directive. S&P 500 Index futures slid as much as 1.6 percent, after the underlying gauge ended up 0.7 percent on Thursday.

So we’ll see what tomorrow brings!

This entry was posted on Thursday, April 5th, 2018 at 7:23 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.