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Front‐Running and Market Quality: An Evolutionary Perspective on High Frequency Trading

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  • Thorsten Hens
  • Terje Lensberg
  • Klaus Reiner Schenk‐Hoppé

Abstract

We study front‐running by high‐frequency traders (HFTs) in a limit order model with continuous trading. The model describes an evolutionary equilibrium of low‐frequency traders who compete in portfolio management services by offering investment styles. The introduction of front‐runners inflicts heavy losses on speculators, while leaving passive investors relatively unscathed. This encourages investment in the market portfolio and markedly reduces overall turnover. Speculative trading persists despite its lower profitability. By most measures, market quality is not affected to any significant extent by front‐running HFTs.

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  • Thorsten Hens & Terje Lensberg & Klaus Reiner Schenk‐Hoppé, 2018. "Front‐Running and Market Quality: An Evolutionary Perspective on High Frequency Trading," International Review of Finance, International Review of Finance Ltd., vol. 18(4), pages 727-741, December.
    • Handle: RePEc:bla:irvfin:v:18:y:2018:i:4:p:727-741
    DOI: 10.1111/irfi.12159
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    Cited by:

    1. Aït-Sahalia, Yacine & Brunetti, Celso, 2020. "High frequency traders and the price process," Journal of Econometrics, Elsevier, vol. 217(1), pages 20-45.
    2. Ziyi Xu & Xue Cheng, 2022. "Are Large Traders Harmed by Front-running HFTs?," Papers 2211.06046, arXiv.org, revised Jul 2023.

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