Abstract
The effectiveness of liquidity provision by HFT firms via the limit order book is an unexplored but central policy issue. Using a unique dataset consisting of limit order placement, execution, and cancellations on Nasdaq, we find that HFT firms do not cancel orders more frequently than non-HFT firms. HFT firms more effectively use order cancellation to strategically manage their limit orders in anticipation of short-term price movements than non-HFT firms. HFT firms increase their liquidity provision during periods of high volatility; their liquidity provision is less affected by order imbalance shocks than that of non-HFT firms. Overall, our results indicate that HFT limit orders exert a stabilizing influence on markets.
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