Technological disparity and its impact on market quality

Abstract

Technological investments made by speed-sensitive market participants are increasingly frequent and have thus been a focal point of recent research. We examine an important, but unexplored facet of this trend: the technological disparity between the fastest market participants and the exchange itself. Using a proprietary dataset of a high-frequency market maker's limit orders and order acknowledgments timestamped to the nanosecond, we explore the consistency and reliability of an exchange's ability to discern the correct sequence of orders when messages are submitted in rapid (sub-microsecond) succession. We find a high degree of variability in acknowledgement times, and the proportion of times in which the first order entered is also first to be acknowledged is surprisingly low when consecutive orders are placed at very high frequencies. Furthermore, we provide evidence of impaired market quality as a result. These issues remain pertinent even following substantial technological improvements made by the exchange, because of the ongoing technological disparity between the exchange and the fastest market participants, who continue to competitively invest in technological improvements.