High frequency trading and the 2008 short-sale ban

We examine the effects of high-frequency traders (HFTs) on liquidity using the September 2008 short sale-ban. To disentangle the separate impacts of short selling by HFTs and non-HFTs, we use an instrumental variables approach exploiting differences in the ban’s cross-sectional impact on HFTs and non-HFTs. Non-HFTs’ short selling improves liquidity, as measured by bid-ask spreads. HFTs’ short selling has the opposite effect by adversely selecting limit orders, which can decrease liquidity supplier competition and reduce trading by non-HFTs. The results highlight that some HFTs’ activities are harmful to liquidity during the extremely volatile short-sale ban period. © 2017 Elsevier B.V. All rights reserved. We thank Frank Hatheway and Jeff Smith at Nasdaq OMX for providing data and comments. Nasdaq makes the data freely available to academics providing a project description and signing a nondisclosure agreement. We thank Ekkehart Boehmer for providing the list of matching firms. We have benefited from discussions with Amy Edwards, Jasmin Gider, Larry Harris, Charles Jones, Bryan Lim, Yue Liu, Pete Kyle, Katya Malinova, Andriy Shkilko, Elvira Sojli, Wing Wah Tham, and Julie Wu. We also thank seminar participants at the Banff International Research Station High-Frequency Trading Workshop, the Conference on the Industrial Organization of Securities and Derivatives Markets: High-Frequency Trading, the Finance Down Under Conference, the 2013 Financial Markets Research Center Conference (Vanderbilt University), the Northern Finance Association, the Queen’s University and Ivey Business School Joint Seminar, the Securities and Exchange Commission, the Sixth Annual Notre Dame Conference on Financial Regulation, the Paris Market Microstructure Conference, the Tsinghua Finance Workshop, the University of Washington, the University of California, Berkeley, the University of Texas at Austin, Rice University, State University of New York at Buffalo, and the Workshop on High-Frequency Trading and Algorithmic Trading in Financial Markets (City University Hong Kong). All errors are our own. ∗ Corresponding author. E-mail address: [email protected] (J. Brogaard). http://dx.doi.org/10.1016/j.jfineco.2017.01.008 0304-405X/© 2017 Elsevier B.V. All rights reserved.