Mrs Joanna Bosredon Essay

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IDEI - 769 February 2013 Equilibrium Fast Trading Sophie Moinas, Bruno Biais and Thierry Foucault Equilibrium Fast Trading 1 Bruno Biais Toulouse School of Economics (CNRS-CRM and FBF-IDEI Chair on Investment Banking and Financial Markets) Thierry Foucault HEC, Paris Sophie Moinas Toulouse School of Economics (IAE-CRM and FBF-IDEI Chair on Investment Banking and Financial Markets) February 7, 2013 Abstract High– speed market connections and information processing improve …nancial institutions’ability to seize trading opportunities, which raises gains from trade. They also enable fast traders to process information before slow traders, which generates adverse selection. We …rst analyze trading equilibria for a given level of investment in fast– trading technology and then endogenize this level. Investments can be strategic substitutes or complements. In the latter case, investment waves can arise, where institutions invest in fast– trading technologies just to keep up with the others. When some traders become fast, it increases adverse selection costs for all, i.e., it generates negative externalities. Therefore equilibrium investment can exceed its welfare– maximizing counterpart. Many thanks for helpful comments to Alex Guembel, Terrence Hendershott, Carolina Manzano, Albert Menkveld, Anya Obizhaeva, Rafael Repullo, Ailsa Roëll, Xavier Vives and participants in the conference on "High Frequency Trading: …nancial and regulatory implications" in Madrid, the 2012 SFS …nance cavalcade and the 2013 American Finance Association Meetings. Moinas acknowledges the support of ANR (ANR-09-JCJC-0139-01). Biais acknowledges the support of the ERC (Grant 295484 - TAP.) Corresponding author: Bruno Biais, Toulouse School of Economics, 21 Allée de Brienne, 31500 Toulouse, France. Tel: 33 5 61 12 85 98. Fax: 33 5 61 12 86 37. email:

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