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, modeling various forms of cross-sectional and temporal dependence, as well as studying each market separately