A Theory of High Frequency Market Making in Fragmented Markets

Abstract

I examine the impact of high frequency (“fast”) market making on liquidity, price discovery and institutional traders’ returns in a setting with market fragmentation. Faster market makers more precisely monitor orderflows across trading venues than slower market makers. If every market maker’s speed increases, I find that liquidity and price discovery improve at all trading venues while institutional traders’ returns decline. When the market makers’ speeds increase at a specific trading venue, liquidity and price discovery at that venue improve and spillovers affect the other venues. If the market makers at the other trading venues are sufficiently slow, the spillovers positively affect liquidity and price discovery at those venues; otherwise, the spillovers harm liquidity and price discovery.