2017/09/06 by René Carmona, Carmona, Rene, Kevin Webster +1
Economics, Econometrics and Finance · #2010: 91G99 #91G20 #91G80 #Complex Systems and Time Series Analysis #FOS: Economics and business #Financial Markets and Investment Strategies #Financial Risk and Volatility Modeling #Trading and Market Microstructure (q-fin.TR)
paper · pdf · doi:10.48550/arxiv.1709.02015
openalex publication_date 2017/09/06 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
We present a novel approach to describing the microstructure of high frequency trading using two key elements. First we introduce a new notion of informed trader which we starkly contrast to current informed trader models. We describe the exact nature of the `superior information' high frequency traders have access to, and how these agents differ from the more standard `insider traders' described in past papers. This then leads to a model and an empirical analysis of the data which strongly supports our claims. The second key element is a rigorous description of clearing conditions on a limit order book and how to derive correct formulas for such a market. From a theoretical point of view, this allows the exact identification of two frictions in the market, one of which is intimately linked to our notion of `superior information'. Empirically, we show that ignoring these frictions can misrepresent the wealth exchanged on the market by 50%. Finally, we showcase two applications of our approach: we measure the profits made by high frequency traders on NASDAQ and re-visit the standard Black - Scholes model to determine how trading frictions alter the delta-hedging strategy.