High-Frequency Trading and Market Quality: Evidence from Account-Level Futures Data

We use rich regulatory data on intraday transactions and end-of-day positions of traders in nine futures markets over the past ten years to examine how participation of high-frequency traders (HFTs) affects market quality. Absence of market fragmentation and off-exchange trading in the contracts under consideration, as well as our use of traded bid-ask spreads in addition to the Amihud price impact, allow for a reliable measurement of market quality and HFT activity. Panel estimation evidence shows that greater participation by HFTs is strongly associated with improvements in market quality, although higher rates of aggressive trading on the part of the HFTs, such as those observed when HFTs trade directionally to reduce their positions, produce an adverse effect on market quality. Our results suggest that the market quality improvements brought about by HFTs’ market-making outweigh the negative effects of HFTs’ aggressive directional trading. We also find that while futures contracts are sensitive to market uncertainty, as measured by VIX, they are even more sensitive to own price volatility. Additionally, we take advantage of the 2015 change in CME’s daily settlement methodology for agricultural commodities to address potential endogeneity using a fixed-effects difference-in-difference setup. Our results are robust to relying on alternative estimation techniques, using overly conservative (clustered) standard errors, ∗For helpful comments we thank Andrei Kirilenko, Wenwei Lin (discussant), Esen Onur, Michael Penick, Michel Robe, Pradeep Yadav (discussant), session participants at the 2022 Financial Markets and Corporate Governance conference, the 2022 Commodity and Energy Markets Association conference, and participants of the CFTC’s Office of the Chief Economist research seminar. The authors are solely responsible for any errors or omissions. The research presented in this paper is coauthored by Commodity Futures Trading Commission (CFTC) economists in their official capacities with the CFTC. The analyses and conclusions expressed in this paper are those of the authors and do not reflect the views of other Commission staff, the Office of the Chief Economist, or the Commission. †U.S. Commodity Futures Trading Commission, 1155 21st Street NW, Washington, DC 20581, USA; jcoughlan@cftc.gov. ‡Corresponding author. U.S. Commodity Futures Trading Commission, 1155 21st Street NW, Washington, DC 20581, USA; aorlov@cftc.gov. modeling various forms of cross-sectional and temporal dependence, as well as studying each market separately.