Surprise! High frequency trading plays a dysfunctional role in the markets

A new study by Robert Jarrow and Philip Protter of Cornell discusses the role of high frequency trading in the markets. Rather than arbitraging away mispricings, they create them in order to exploit ordinary investors:

This paper shows that high frequency trading may play a dysfunctional role in financial markets. Contrary to arbitrageurs who make financial markets more efficient by taking advantage of and thereby eliminating mispricings, high frequency traders can create a mispricing that they unknowingly exploit to the disadvantage of ordinary investors. This mispricing is generated by the collective and independent actions of high frequency traders, coordinated via the observation of a common signal.

Read the full study here.

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