Time to Slow Down for High‐Frequency Trading? Lessons from Artificial Markets

• DOI: http://doi.org/10.1002/isaf.1407
• Published date: 01 April 2017
• Author: Lise Arena,Etienne Harb,Iryna Veryzhenko,Nathalie Oriol
• Date: 01 April 2017

DOI: 10.1002/isaf.1407

SPECIAL ISSUE ARTICLE

Time to Slow Down for High-Frequency Trading? Lessons from

Artificial Markets

Iryna Veryzhenko1Lise Arena2Etienne Harb3Nathalie Oriol4

1LabexReFi, LIRSA-CNAM, 40 rue des

Jeûneurs, 75002, Paris,France

2GREDEG-UniversitéNice Sophia-Antipolis

3Essca Research Lab, 55 Quai Alphonse le

Gallo, 92513, Boulogne-Billancourt, France

4Côte d'Azur University - SRM - GREDEG -

CNRS, 250 rue Albert Einstein, 06560

Valbonne,France

Correspondence

Iryna Veryzhenko,LabexReFi, LIRSA-CNAM,

40 rue des Jeûneurs, 75002, Paris,France.

Email: iryna.veryzhenko@cnam.fr

Summary

In this paper,we focus on the French cancel order tax implemented on 1 August 2012. We ques-

tionthe effectiveness of the modified tax with no exemptions and we analyze its impact on market

quality,measured by liquidity,volatility and efficiency.Additionally, this paper raises the question

whether this tax leads to a reduction of high-frequency trading (HFT) activities and a decline in

tradingvolume. Based on our findings we report that introduction of cancel order tax only slightly

reduces HFT activities, but it significantly affects marketliquidity, increases marketvolatility and

leads to deterioratingmarket efficiency.We conclude that it is difficult to dissuade investors from

entering into unproductivetrades and eliminate negative outputs of HFT (such as price manipula-

tions) through tax, without altering the benefits of HFT likeliquidity provision and efficient price

discovery.

KEYWORDS

agent-based modelling, HFT, marketquality, market regulation, microstructure

1INTRODUCTION

The High FrequencyTrading(HFT) is the most controversial and poorly

understood phenomenon of the financial market. The literature pro-

vides contradictoryfindings about the impact of HFT on market quality.

HFT activities are often considered as purely speculative and destabi-

lizing tradingstrategies. The literature does provide empirical evidence

of a positive correlation between HFT and increasing volatility(Zhang,

2010; Boehmer, Fong, & Wu, 2012). In fact, HFT is blamed for the

flash crash of May 2010 (Kirilenko,Kyle, Samadi, & Tuzun, 2010). It is

assumed that the speed of HFT creates an unfair and unstable market

conditions.

However, evidence also exists to suggest that the majority of HFT

trading volumecontributes to liquidity provision. Quantitative trading

strategies, typical for high frequency trading, increase the number of

smaller orders and enable a more efficient allocation and price discov-

ery (Pastor & Strambaugh,2003; Acharya & Pedersen, 2005; Chordia,

Roll, & Subrahmanyam, 2008; Ekkehart& Kelley, 2009). Hendershott,

Jones, and Menkveld (2011a) state that the increased order flow from

HFT improves marketliquidity. Using Deutsche Boerse data, Hender-

shott and Moulton (2011) find no evidence of increasing volatility due

toHFT,similar results are reported by Hasbrouck and Saar (2010), using

NASDAQdata.

Despite mixed opinions in the literature, all practitioners and aca-

demics agree that HFT practices increase the message traffic on the

market, reducing its tractability and transparency. New market regu-

lation is needed to deal with the HFT and the emerging phenomena

related to these practices (Mizuta et al., 2016; Jain & Jordan, 2016).

The introduction of “good” HFT regulation is not a simple task, since

HFTs are heterogeneous and have heterogeneous impacts on market

quality.Thus, a “good” regulation should be the most predictable and

adaptive one. Predictable because its positive and negative potential

effects should be well-understood exante, and adaptive, because regu-

lators must haveappropriate tools to evaluate the impact of new rules

ex-postfor readjustments.

On 1 August 2012, the Frenchgovernment proposed a new financial

transaction tax. It included three different taxes:i) a t ax on the acqui-

sition of equity securities ii) a tax on high frequency trading and iii) a

tax on naked sovereign credit default swaps (CDS). In this paper, we

focus on the second tax, a 0.01 percent tax on the amount of canceled

or modified orders within a half of a second timespan, on any given

trading day exceeding 80% threshold of total trading orders. This tax

concerns only Frenchactors, who are actually minimally affected as an

exemptionwas applied to market-making activities and because of the

very high thresholds. Based on the first results, the government esti-

mated that the tax on high-frequency trading generatedno revenue in

2012. This phenomenon can be explainedby the long list of exemptions

implemented bythe French regulator,who faced a dilemma. On the one

hand, regulators wanted to achieve a stable economic environment,

making speculation unprofitable. On the other hand, they did not want

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