Marius Zoican PRO
I am an Associate Professor of Finance and Canada Research Chair in Financial Technology at the University of Calgary’s Haskayne School of Business. My research sits at the intersection of technology and finance.
Michael Brolley and Marius Zoican
Southern Finance Association November 19, 2020
Liquid speed:
a congestion fee for low-latency exchanges
Who really needs to trade at warp speed?
- HFTs provide price discovery as both makers and takers
- However, they also to capture latency arbitrage rents.
- Speed inequality can adversely effect liquidity (Shkilko & Sokolov, 2020).
- Should we tinker with or overhaul our market design? (Baldauf & Mollner 2020; Brolley & Cimon 2020; Haas,Khapko, & Zoican 2020).
- Exchanges charge HFTs for "co-location": revenues between $874M-$1024M in 2018
- Co-location revenue on par with trading fees revenue.
How much speed do we really need?
Our paper
- Main idea: Surge pricing of speed (à la Uber).
- How? Implement a congestion fee on liquidity taking orders.
- Charge a uniform fee to each liquidity-taking order message whenever there are multiple take orders in a short time interval.
- Fee level the number of take orders, surging during micro-bursts.
- Latency arbitrage externalities are (partially) priced in.
- A system that is incentive-compatible for exchanges.
\uparrow
Status quo: Latency arbitrage rent-sharing
Ideal world: No latency arbitrage rents
Our idea: Incentive-compatible rent transfer from HFTs to investors
Asset
- One risky asset, for which news arrives with probability .
- It pays off:
\delta
\tilde{v}=\begin{cases}
v+\sigma, & \text{if ``good news'' arrives} \\
v-\sigma, & \text{if ``bad news'' arrives} \\
v, & \text{if no news arrives}.
\end{cases}
Traders
- risk-neutral high-frequency traders (HFT) who submit market or limit orders.
- Liquidity investors (also risk neutral), arrive at the market with probability .
- Liquidity investors only submit market orders are equally likely to buy/sell.
H\geq 3
1-\delta
Congestion fee
If HFT "snipers'' submit a marketable order simultaneously, each is charged a fee
k\geq 2
f\left(k\right)=\begin{cases}
\phi \left(k-1\right) & \text{ if } k\geq 2 \\
0 & \text{ if } k=1.
\end{cases}
- Congestion fee number of liquidity-taking orders received by the exchange in a short time interval (100 s to 10 ms).
- Single marketable order arrives congestion fee is zero.
- Congestion fees are computed from intraday, but charged daily (or monthly, even).
- Unlikely that liquidity traders pay congestion fees. Estimated total duration of HFT races in FTSE100 stocks:
\propto
\mu
\Rightarrow
537 \text{ races/day} \times 81 \text{ $\mu$s/race} = 0.043 \text{ seconds/day}.
Impact of fee on liquidity and race intensity
A larger congestion fee leads to:
- Narrower spreads;
- Lower sniping probability
What about fee revenues?
- Direct effect: implies higher revenues for each trade;
- Indirect effect: reduces HFT incentives to snipe less intense races.
\phi \nearrow
\phi \nearrow
\Longrightarrow
A regulator’s optimal fee choice
- Implement a "surge pricing of speed'' (a la Uber) on liquidity taking orders.
- Charge HFTs a fee whenever there are multiple liquidity-taking orders in a short time interval.
- Quick calibration indicates fee in the range of 15%-35% relative to the average arbitrage opportunity. (using Aquilina, Budish, and O'Neill, 2020).
- Latency arbitrage externalities are (partially) priced in.
- Incentive-compatible for exchanges (i.e., competition-proof vs. co-location fees).
Conclusions
Liquid Speed: A Congestion Fee for Low-Latency Exchanges
By Marius Zoican
Liquid Speed: A Congestion Fee for Low-Latency Exchanges
Southern Finance Association presentation on November 19, 2020.
