《High Frequency Traders》.pdf

High Frequency Traders, News and Volatility∗ Victor H. Martinez† Ioanid Ro¸su‡ December 29, 2011 Abstract This paper offers a rationale for high frequency trading. We model high fre- quency traders (HFTs) as informed traders that observe a continuous stream of signals, called news, and have uncertainty aversion regarding the level of the asset value. We find that (i) HFTs generate most of the volatility and trading volume in the market, in contrast with what other dynamic information models with price impact predict; (ii) HFTs must use their information quickly, because an instant later they take a significant percentage loss; (iii) when the number of HFTs in- creases, volatility stays constant, while volume and liquidity increase; (iv) when the HFTs’ news precision increases, volatility and volume increase, while liquid- ity decreases. Rather than destabilizing markets, HFTs make the markets more efficient by incorporating most of the new information as soon as it gets revealed to them. Keywords: Insider trading, Kyle model, noise trading, trading volume, al- gorithmic trading, informed volatility, price impact, inventory, mark-to-model. ∗We thank Kerry Back, Laurent Calvet, Thierry Foucault, Johan Hombert, Pete Kyle, Stefano Lovo, Jacques Olivier, Jiang Wang; seminar participants at HEC Paris and Durham Business School; and conference participants at the Society for Advancement of Economic Theory, Portugal, and the Central Bank Market Microstructure Workshop, Norway, for valuable comments. †Baruch College, CUNY, Zicklin School of Business, Email: victor martinez@. ‡HEC Paris, Email: rosu@hec.fr.