Abstract
We examine the soundness of high-frequency trading (HFT) proxies that are widely defined on the limit order book (LOB) information. We use a unique TRTH (Thomson Reuters Tick History) millisecond time-stamped intraday trades and quotes dataset enriched with 10 levels of LOB depth messages for 149 highly fragmented LSE listed stocks for the period 2005 to 2016. We explore a sharp uptrend in HFT activities and accompanying improvement in market liquidity in the European market. We show that alternative HFT proxies built on LOB are not equally powerful. The HFT proxy defined on the five best LOB prices (the mid point of a typical limit order book) provides a better HFT identification than the one popularly defined on the first best prices (BBO). We suggest that picking the LOB information beyond a certain level (e.g., the best five prices) of market depth in developing HFT proxy is counterintuitive. Evidence indicates that high-frequency traders (HFTs) participate in both competitive (narrow) and passive (wider) quoting as a market making strategy; however, they do not participate in passive quoting excessively.
Highlights
For the last two decades, the advent of sophisticated computing technology has been changing the financial market structure unprecedentedly
The analyses show that the high-frequency trading (HFT) proxy defined on the first best bid and offer prices (BBO) fails to include the footprints that HFTs leave on a typical limit order book through their passive quoting
Based on the evidence we provide from the related studies, it manifests that defining the electronic message rate only on the BBO level information does not depict a full HFT image, and raises the concerns of under or over identification
Summary
For the last two decades, the advent of sophisticated computing technology has been changing the financial market structure unprecedentedly. A first-hand analysis shows that Hendershott et al (2011)’s proxy (dollar volume per electronic message times (−1)) does not appropriately fit in the European equity market setting for the sample period under our consideration1 Another proxy, order to trade ratio, has the same limitation. To our knowledge, this is the first study of its kind to evaluate the alternative high-frequency trading proxies built on limit order book information It provides evidence regarding the high-frequency trading intensity and market liquidity changes in the European equity market covering one of the longest periods, using an original dataset.
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