High‐Frequency Traders and Market Structure

• Date: 01 May 2014
• DOI: http://doi.org/10.1111/fire.12038
• Published date: 01 May 2014

The Financial Review 49 (2014) 333–344

High-Frequency Traders and

Market Structure

Albert J. Menkveld*

VU University Amsterdam

TinbergenInstitute

Duisenberg School of Finance

Abstract

The arrival of high-frequency traders (HFTs) coincided with the entry of new markets

and, subsequently,strong fragmentation of the order flow. These trends might be related as new

markets serve HFTs who seek lowfees and high speed. New markets only thrive on competitive

price quotes that well-connected HFTs can deliver as they can offload any nonzero position in

any market they are connected to. HFTs may benefit or hurt market quality through adverse

selection on price quotes, a technology arms race, or high-risk trading strategies.

Keywords: high-frequency traders, market fragmentation, market structure

JEL Classification:G10

∗Corresponding author: Finance Department, VU University Amsterdam, De Boelelaan 1105, 1081 HV

Amsterdam, The Netherlands; Phone: +31 20 598 6130; E-mail: albertjmenkveld@gmail.com.

This paper is based on a driver review report (DR16) written for the 2012 U.K. Government’s Foresight

Project: “The Future of Computer Trading in Financial Markets.” I would like to thank Ian Domowitz,

Stephen Figlewski, Thierry Foucault, two anonymousreferees, Michael Goldstein (guest editor), Terrence

Hendershott, Charles Jones, Oliver Linton, Emiliano Pagnotta, and Bart Yueshen for their feedback. I

gratefully acknowledge VU University Amsterdam for a VU talent grant and NWO for a VIDI grant.

C2014The Eastern Finance Association 333