E ects of Information Transmission by High Frequency Traders on Market Quality

We develop a two period model of trade where an insider, a noise trader, a high frequency trader (HFT) and a market maker trade a divisible asset that has a common value in two parallel markets. The market makers set competitive prices in both markets. We analyze the e ects of the high frequency trader, who can gain from observing prices across markets, on market quality. Even though informed traders can transfer information across markets that is potentially useful in setting a more accurate price for the asset, we show that due to strategic interactions between the insider and the HFT, price discovery does not improve. Also, we show that HFT has a negative e ect on market liquidity. ∗Robinson College of Business, Georgia State University. Email: [email protected] †Haas School of Business, University of California, Berkeley. Email: [email protected] 1