The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response

The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response

Coauthors: Peter Cramton and John Shim
The Quarterly Journal of Economics, (2015): 130, no. 4, 1547-1621. [PDF]


The high-frequency trading arms race is a symptom of flawed market design. Instead of the continuous limit order book market design that is currently predominant, we argue that financial exchanges should use frequent batch auctions: uniform price double auctions conducted, for example, every tenth of a second. That is, time should be treated as discrete instead of continuous, and orders should be processed in a batch auction instead of serially. Our argument has three parts. First, we use millisecond-level direct-feed data from exchanges to document a series of stylized facts about how the continuous market works at high-frequency time horizons: (i) correlations completely break down; which (ii) leads to obvious mechanical arbitrage opportunities; and (iii) competition has not affected the size or frequency of the arbitrage opportunities, it has only raised the bar for how fast one has to be to capture them. Second, we introduce a simple theory model which is motivated by and helps explain the empirical facts. The key insight is that obvious mechanical arbitrage opportunities, like those observed in the data, are built into the market design—continuous-time serial-processing implies that even symmetrically observed public information creates arbitrage rents. These rents harm liquidity provision and induce a never-ending socially wasteful arms race for speed. Last, we show that frequent batch auctions directly address the flaws of the continuous limit order book. Discrete time reduces the value of tiny speed advantages, and the auction transforms competition on speed into competition on price. Consequently, frequent batch auctions eliminate the mechanical arbitrage rents, enhance liquidity for investors, and stop the high-frequency trading arms race.


Winner- 2014 AQR Insight Award

Winner- 2015 Utah WFC Best Paper Award



Online Appendices with Peter Cramton and John Shim. The Quarterly Journal of Economics 130, no. 4 (2015): 1547-1621.. [PDF]

Policy Discussion

SEC Chair White Speech

Enhancing Our Equity Market Structure, Speech, SEC Chair Mary Jo White, June 5, 2014. [PDF]

New York Attorney General Speech

Remarks on High-Frequency Trading & Insider Trading 2.0, New York Law School Panel on “Insider Trading 2.0 — A New Initiative to Crack Down on Predatory Practices,” March 18, 2014. [PDF]

Policy Writing

Response to ESMA’s Call for Evidence re Periodic Auctions

Response to ESMA’s Call for Evidence: “Periodic Auctions for Equity Instruments” (ESMA70-156-785), January 2019.
[PDF] [All Related Material]

Response to RFI on the Evolution of the U.S. Treasury Market Structure

Response to RFI on the Evolution of the U.S. Treasury Market Structure, Re: Notice Seeking Public Comment on the Evolution of the Treasury Market Structure (Docket No. TREAS-DO-2015-0013), April 2016.
[PDF] [All Related Material]

Comment Letter on Proposed Commission Interpretation of One Millisecond as De Minimis

Re: Proposed Commission Interpretation Regarding Automated Quotations Under Regulation NMS (Release No. 34-77407; File No. S7-03-16), April 2016.
[PDF] [All Related Material]

IEX Comment Letter

Re: Investors’ Exchange LLC Form 1 Application (Release No. 34-75925; File No. 10-222), February 2016.
[PDF] [All Related Material]

CFTC Comment Letter

Re: CFTC Concept Release — Risk Controls and System Safeguards for Automated Trading Environments, RIN 3038-AD52, February 2014.
[PDF] [All Related Material]

Press Coverage

Slowing Down the Stock Market

Bloomberg Editorial, Editorial Board, Jun 18, 2014 [PDF]

Everything You Need to Know About High-Frequency Trading

The Atlantic, Matthew O’Brien, Apr 11, 2014 [PDF]

Professor Proposes Slowing Down Automated Trading

Chicago Tribune, Ameet Sachdev, Mar 30, 2014 [PDF]

Declawing Speed Traders Is Goal of Stock Market Revamp Proposal

Bloomberg, Sam Mamudi, Feb 19, 2014 [PDF]

The Need for Less Speed

Financial Times, Tim Harford, Jul 06, 2013 [PDF]

Panel Discussion

CFTC’s Technology Advisory Committee Meeting

Commody Futures Trading Commission, February 2014.

Is high frequency trading good for financial markets?

Chicago Booth Review, October 2013.

Related Works

Implementation Details for Frequent Batch Auctions: Slowing Down Markets to the Blink of an Eye

Peter Cramton and John Shim
American Economic Review: Papers & Proceedings, (2014): 104, no. 5, 418-424. [PDF]

Our recent research (Budish, Cramton, and Shim 2013) proposes frequent batch auctions—uniform-price sealed-bid double auctions conducted at frequent but discrete time intervals—as a market design alternative to continuous-time trading in financial markets. This short paper discusses the implementation details of frequent batch auctions. We outline the process flow for frequent batch auctions, discuss a modification to the market design that accommodates market fragmentation and Reg NMS, and discuss the engineering and economic considerations relevant for determining the batch interval. Open questions are discussed throughout.


Policy Audience Slides (FCA, Feb 2016)


Seminar Slides (Sept 2015)

Seminar Slides, with Peter Cramton and John Shim. September 2015. [PDF]