Too Fast or Too Slow? Determining the Optimal Speed of Financial Markets

Daniel Fricke and Austin Gerig

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Abstract:

How fast should a security trade? To answer this question, we model the trading of a security via periodic batch auctions and study how market quality is affected as the clearing frequency is changed. In the model, the optimal clearing frequency depends on three factors: (1) the volatility of the security, (2) the intensity of trading in the security, and (3) the correlation of the security's value with other securities. Using rough estimates for these values, we determine that the ideal interval of trade for a typical U.S. stock is currently 0.2 to 0.9 seconds. Our analysis suggests that speed is important in financial markets and that time delays of even a fraction of a second can harm market quality. On the other hand, our results also suggest that for many securities, milli- and microsecond speeds are unnecessary.