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Abnormal Profit Opportunities and the Informational Advantage of High Frequency Trading

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  • Robert Jarrow

    (Samuel Curtis Johnson Graduate School of Management, Cornell University, Ithaca, N.Y. 14853, Kamakura Corporation, USA)

  • Hao Li

    (Samuel Curtis Johnson Graduate School of Management, Cornell University, Ithaca, N.Y. 14853, USA)

Abstract

In a frictionless and competitive economy, where high frequency (HF) traders possess no market power, this paper characterizes necessary and sufficient conditions on the price process and information sets for HF traders to earn abnormal trading profits. Two sufficient conditions shown to generate abnormal returns are that HF trading enables the observation of short-term price momentum/reversals, not otherwise visible, or it enables the observation of signals correlated to future price movements. The welfare considerations of the existence of such abnormal trading profits are also discussed.

Suggested Citation

  • Robert Jarrow & Hao Li, 2013. "Abnormal Profit Opportunities and the Informational Advantage of High Frequency Trading," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 3(02), pages 1-12.
    • Handle: RePEc:wsi:qjfxxx:v:03:y:2013:i:02:n:s2010139213500122
    DOI: 10.1142/S2010139213500122
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    References listed on IDEAS

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    1. Benos, Evangelos & Sagade, Satchit, 2012. "High-frequency trading behaviour and its impact on market quality: evidence from the UK equity market," Bank of England working papers 469, Bank of England.
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    4. Menkveld, Albert J., 2013. "High frequency trading and the new market makers," Journal of Financial Markets, Elsevier, vol. 16(4), pages 712-740.
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