Technology and market quality: the case of high frequency trading

Technological innovations such as high frequency trading systems (HFT) and algorithmic trading systems have changed financial markets. We discuss technological and economic aspects of HFT and find that HFT have a major impact on all aspects of the internal market structure of exchanges. We use market quality measures on a unique dataset provided by NASDAQ in order to analyze the contribution of HFT to market quality. The empirical results are discussed in the context of external and internal factors of market quality. Our results indicate considerable differences in trading strategies: HFT engage in market making strategies and provide liquidity when it is expensive and demand liquidity when it is cheap. Their trades are more informed than non-HFT trades for stocks with a high market capitalization and therefore make prices more informative, but less informed across the entire sample.