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Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market

Journal article
Authors A. P. Chaboud
B. Chiquoine
Erik Hjalmarsson
Clara Vega
Published in Journal of Finance
Volume 69
Issue 5
Pages 2045-2084
ISSN 0022-1082
Publication year 2014
Published at Centre for Finance
Department of Economics
Pages 2045-2084
Language en
Links dx.doi.org/10.1111/jofi.12186
Keywords Algorithmic trading, Price discovery
Subject categories Economics and Business

Abstract

We study the impact of algorithmic trading (AT) in the foreign exchange market using a long time series of high-frequency data that identify computer-generated trading activity. We find that AT causes an improvement in two measures of price efficiency: the frequency of triangular arbitrage opportunities and the autocorrelation of high-frequency returns. We show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity. This result is consistent with the view that AT improves informational efficiency by speeding up price discovery, but that it may also impose higher adverse selection costs on slower traders. In contrast, the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence consistent with the strategies of algorithmic traders being highly correlated. This correlation, however, does not appear to cause a degradation in market quality, at least not on average.

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