Does Algorithmic Trading Improve Liquidity?
Article first published online: 6 JAN 2011
© 2011 the American Finance Association
The Journal of Finance
Volume 66, Issue 1, pages 1–33, February 2011
How to Cite
HENDERSHOTT, T., JONES, C. M. and MENKVELD, A. J. (2011), Does Algorithmic Trading Improve Liquidity?. The Journal of Finance, 66: 1–33. doi: 10.1111/j.1540-6261.2010.01624.x
- Issue published online: 6 JAN 2011
- Article first published online: 6 JAN 2011
Algorithmic trading (AT) has increased sharply over the past decade. Does it improve market quality, and should it be encouraged? We provide the first analysis of this question. The New York Stock Exchange automated quote dissemination in 2003, and we use this change in market structure that increases AT as an exogenous instrument to measure the causal effect of AT on liquidity. For large stocks in particular, AT narrows spreads, reduces adverse selection, and reduces trade-related price discovery. The findings indicate that AT improves liquidity and enhances the informativeness of quotes.