Research / BFI Working PaperJul 22, 2020

A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?

Eric Budish, Robin S. Lee, John J. Shim

This paper builds a new model of financial exchange competition, tailored to the institutional details of the modern US stock market. In equilibrium, exchange trading fees are competitive but exchanges are able to earn economic profits from the sale of speed technology. We document stylized facts consistent with these results. We then use the model to analyze incentives for market design innovation. The novel tension between private and social innovation incentives is incumbents’ rents from speed technology in the status quo. This creates a disincentive to adopt new market designs that eliminate latency arbitrage and the high-frequency trading arms race.

More Research From These Scholars

BFI Working Paper Jan 30, 2021

Preparing for a Pandemic: Accelerating Vaccine Availability

Amrita Ahuja, Susan Athey, Arthur Baker, Eric Budish, Juan Camilo Castillo, Rachel Glennerster, Scott Duke Kominers, Michael Kremer, Jean Lee, Canice Prendergast, Christopher M. Snyder, Alex Tabarrok, Brandon Joel Tan, Witold Wiecek
Topics:  COVID-19, Health care
BFI Working Paper Jun 25, 2020

Quantifying the High-Frequency Trading “Arms Race”: A Simple New Methodology and Estimates

Matteo Aquilina, Eric Budish, Peter O’Neill
Topics:  Financial Markets