• Banking and Finance in Historical Perspective
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40. Jahrgang | Jahr 2014 | Heft 1



Hans-Peter Burghof / Carolin Koch / Sebastian Schroff / Ulli Spankowski
From Traditional Floor Trading to Electronic High Frequency Trading (HFT) – Market Implications and Regulatory Aspects
In this paper, we study how the technology-driven rise in automated high frequency trading (HFT) strategies affects the functioning of today’s financial markets. We focus on how HFT affects market quality as well as systemic risk and overall economic welfare. First, we describe the emergence of fully automated electronic markets as a prerequisite for HFT. We note that the generic term of HFT covers the activities of a large variety of high frequency traders who perform fundamentally different HFT strategies. A review of the results of different studies shows that the impact of HFT on liquidity, volatility and the speed of price discovery is mainly positive and that HFT activities in this sense can positively influence market quality. However, these benefits often do not persist in turbulent market conditions when they are needed most. In addition, studies show that negative externalities of HFT (e. g., flash crashes) pose a significant threat to financial stability. Based on these findings, we discuss current regulatory initiatives in Europe. We argue that regulation can only be successful if it targets HFT strategies separately and manages to ban harmful strategies (e. g., front running, quote stuffing) and maintain beneficial ones (e. g., market making).

Since the creation of exchanges, the ability to achieve information faster than other market participants and the skill to benefit from this informational advantage played a crucial role in the determination of success and failure in trading. The means of both achieving and transferring information and the ways how market participants are able to trade on information changed a lot over the centuries and even more so in the last decades. In this process of change, new technologies for the processing of information are as relevant as the legal and institutional framework. E. g., the classical insider trading, which played a large role for the process of diffusion of new information into the market in a not too recent past, is banned in most countries today and thereby more or less effectively prohibited. Furthermore, the organizational form of trading has changed over time. In most exchanges open order books supplanted to a high degree the classical auction-like forms which were used to aggregate liquidity before.[…]