The Quote Exception Rule: Giving High Frequency Traders an Unintended Advantage

Authors

  • Thomas H. McInish,

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    • Thomas H. McInish is a Professor and Wunderlich Chair of Finance in the Department of Finance, Insurance and Real Estate at Fogelman College of Business and Economics at the University of Memphis in Memphis, TN. James Upson is an Assistant Professor of Finance in the College of Business at the University of Texas at El Paso in El Paso, TX.

  • James Upson

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    • Thomas H. McInish is a Professor and Wunderlich Chair of Finance in the Department of Finance, Insurance and Real Estate at Fogelman College of Business and Economics at the University of Memphis in Memphis, TN. James Upson is an Assistant Professor of Finance in the College of Business at the University of Texas at El Paso in El Paso, TX.


  • The authors wish to thank an anonymous referee, Sie Ting Lau, Bohui Zhang, William T. Smith, Larry Harris, Joel Hasbrouck, Gideon Saar, Maureen O'Hara, and Jonathan Brogaard for helpful comments. We received useful comments from the participants at a Securities and Exchange Commission seminar in September 2011 and the NBER market microstructure conference in December 2011. We also thank Leslie Boni, Marc Lipson, Michael Goldstein, and other seminar participants at the 2012 FMA. Any errors remain our own.

Abstract

Under the Securities and Exchange Commission (SEC) Rule 611 exchanges that have not matched a new National Best Bid and Offer (NBBO) can trade at the old NBBO for one second. In 2008, this rule allowed fast traders to earn estimated revenues of $233 million at the expense of slow traders. Furthermore, we find that when the NYSE decreased latency by 600 milliseconds on March 10, 2008, execution quality improved markedly for fast liquidity demanders, but improved only minimally for slow liquidity demanders. However, we find a decrease in volume executed at adverse prices under the faster market conditions.

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