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Precedence rules in matching algorithms

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  • Haynes, Richard
  • Onur, Esen

Abstract

Markets with time priority rules incentivize efforts to increase trading speeds. In particular, revenues resulting from liquidity provision due to discrete pricing can often accrue to the fastest traders, those who can hold favorable queue positions. We examine the impact of precedence rules for a single market that switched to a first-in-first-out (FIFO) matching algorithm from one primarily based on pro-rata. Due to a technology issue, in May 2015 the two year Treasury futures contract unexpectedly switched from partially pro-rata to FIFO for several days. We study the effects of this switch through a difference-in-difference comparison with a related futures contract that had no change in priority rules. We find that compared to FIFO, orders placed later in time are significantly more profitable under pro-rata. However, the lower profitability of earlier orders in the queue under pro-rata matching causes prices to be less efficient under pro-rata rules. Secondary results find that order sizes and cancellations increase under pro-rata. While analyzed using the Treasury futures market, our findings are applicable to commodity futures as well, where both FIFO and pro-rata are widely used.

Suggested Citation

  • Haynes, Richard & Onur, Esen, 2020. "Precedence rules in matching algorithms," Journal of Commodity Markets, Elsevier, vol. 19(C).
  • Handle: RePEc:eee:jocoma:v:19:y:2020:i:c:s2405851319300741
    DOI: 10.1016/j.jcomm.2019.100109
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    References listed on IDEAS

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    1. Field, Jonathan & Large, Jeremy, 2008. "Pro-rata matching and one-tick futures markets," CFS Working Paper Series 2008/40, Center for Financial Studies (CFS).
    2. Glosten, Lawrence R, 1987. "Components of the Bid-Ask Spread and the Statistical Properties of Transaction Prices," Journal of Finance, American Finance Association, vol. 42(5), pages 1293-1307, December.
    3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    4. Andrew Lepone & Jin Young Yang, 2012. "The impact of a pro‐rata algorithm on liquidity: Evidence from the NYSE LIFFE," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(7), pages 660-682, July.
    5. Eric Budish & Peter Cramton & John Shim, 2015. "Editor's Choice The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 130(4), pages 1547-1621.
    6. Angelo Aspris & Sean Foley & Drew Harris & Peter O'Neill, 2015. "Time Pro‐rata Matching: Evidence of a Change in LIFFE STIR Futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 35(6), pages 522-541, June.
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    Cited by:

    1. Gil Hersch, 2023. "Procedural Fairness in Exchange Matching Systems," Journal of Business Ethics, Springer, vol. 188(2), pages 367-377, November.

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