Research from the U.K.’s Financial Conduct Authority (FCA) estimates that high-frequency trading costs global equity markets US$5 billion annually.
A new paper by a pair of researchers in the FCA’s economics department and a professor from the University of Chicago’s Booth School of Business used stock exchange message data to quantify the impact of so-called “latency arbitrage” — high-speed traders executing against stale quotes.
By using message data rather than order book data, the researchers aimed to capture trading attempts that failed or were cancelled along with successful trade executions, allowing them “to observe both winners and losers in a race,” the paper said.
Based on the data, the researchers found that “latency arbitrage” races are very common (with about one per minute for FTSE 100 stocks). They last only 5-10 millionths of a second, and are involved in about 20% of overall trading volume.
While these races involve only small amounts of money, averaging just over half a tick, they add up, given the trading activity that’s affected.
The research paper estimated that latency arbitrage profits represent 0.42 basis points of total trading, which would amount to £60 million per year in the U.K.
Extrapolating this estimated “latency arbitrage tax” to the global equity markets, the paper found that it would be worth approximately US$5 billion annually, and that eliminating the phenomenon would reduce the costs of trading by about 17%.