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Algorithmic Trading, Price Efficiency and Welfare: An Experimental Approach

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  • Corgnet, Brice
  • DeSantis, Mark
  • Siemroth, Christoph

Abstract

We develop a novel experimental paradigm to study the causal impact of two classes of trading algorithms on price efficiency, trading volume, liquidity, and welfare. In our design, public information about the asset value is revealed during trading, which gives algorithms a reaction speed advantage. We distinguish market-order (aggressive) and limit-order (passive) algorithms, which replace human traders from the baseline markets. Relative to human-only markets, limit-order algorithms improve welfare, although human traders do not benefit, as the surplus is captured by the algorithms. Market-order algorithms do not change welfare, though they do lower human traders’ profits. Both types of algorithms improve price efficiency, lower volatility, and increase the share of profits for unsophisticated human traders. Our results offer unique evidence that non-exploitative algorithms can enhance welfare and be beneficial to unsophisticated traders.
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  • Corgnet, Brice & DeSantis, Mark & Siemroth, Christoph, 2024. "Algorithmic Trading, Price Efficiency and Welfare: An Experimental Approach," VfS Annual Conference 2024 (Berlin): Upcoming Labor Market Challenges 302411, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc24:302411
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    More about this item

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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