Article: Wednesday, 6 July 2016

What impact do high-frequency traders (HFTs) have on the market’s quality in the pre-opening period of the stock market, when traders cannot benefit directly from any speed advantage? Researcher Darya Yuferova of Rotterdam School of Management, Erasmus University (RSM) discovered that 25 per cent of HFTs are active in the pre-opening period on the Tokyo Stock Exchange. She found they play a major role in determining prices and providing liquidity during the pre-opening period and opening call auction that follows. She defended her thesis on 30 June 2016.

Yuferova studied how HFTs impact price discovery and liquidity provision on the Tokyo Stock Exchange (TSE) in a joint work with Mario BelliaLoriana Pelizzon, Marti Subrahmanyam, and Jun Uno. This stock market is one of the biggest markets in the world with a large proportion – 55 per cent – of its turnover generated by HFTs. In her research, Yuferova compared the behaviour of HFTs during three periods: the pre-opening period, during the opening call auction and the regular, continuous trading period.

Only 25 per cent of HFTs participate in the pre-opening period, generating 51 per cent of orders during that time.

Pre-opening period

Between 08:00 and 09:00 orders may be placed on the TSE, but cannot be executed. The time the order was placed doesn’t matter; only price has priority. During this hour, orders can also be cancelled free of charge at any point in time, and at the same time, the TSE disseminates the 10 best bid and ask quotes to the market in real time.  At 09:00, the opening price is determined by means of a single price opening call auction.  After that trading becomes continuous.

Virtual server

To find out about the exact impact of high-frequency trading during those time periods, Yuferova used a large dataset of all orders and trades of the TOPIX100 - major stock market index in Japan - constituents in April and May 2013. She was able to track how traders place the orders by looking at the unique anonymous identifiers (virtual servers) traders use to operate on the TSE.

Price discovery

Yuferova discovered that HFTs are less active during the pre-opening period than the continuous period. Only 25 per cent of HFTs participate in the pre-opening period, generating 51 per cent of orders during that time. Importantly, HFTs that execute their orders in the opening call auction, on average, contribute 9.35 per cent more to the price discovery process (how buyers and sellers determine the price of the asset in the marketplace) in the pre-opening period and 1.11 per cent more to liquidity provision in the opening call auction than other traders.

Yuferova’s results confirm earlier studies that found HFTs contribute to price discovery and liquidity provision. However, she finds there is also considerable heterogeneity among them, in how and when they do this, with a pattern emerging: during the continuous period, price discovery was mostly driven by the three-quarters of HFTs that were inactive in the pre-opening period. And those that were active in the pre-opening period contribute to liquidity provision in the subsequent continuous session.

Once HFT, forever HFT?

Yuferova also found that HFTs are dynamic in changing their presence in different stocks and on different days. Put differently, a trader can operate as a high-frequency trader on one day, and as a moderate-speed trader on another. They can also vary their trading strategies across stocks. Thus, Yuferova found nuances in the image of HFTs as traders that always trade with extremely high speeds across all stocks.

Dr. Darya Yuferova

Associate Professor

Norwegian School of Economics (NHH)

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