What is the Optimal Trading Frequency in Financial Markets?

Haoxiang Zhu, Songzi Du - Jul 06, 2018

Working Paper No.  00039-00

This paper studies the impact of increasing trading frequency in financial markets on
allocative efficiency. We build and solve a dynamic model of sequential double auctions
in which traders trade strategically with demand schedules. Trading needs are generated
by time-varying private information about the asset value and private values for owning
the asset, as well as quadratic inventory costs. We characterize a linear equilibrium with
stationary strategies and its eciency properties in closed form. Frequent trading (more
double auctions per unit of time) allows more immediate asset reallocation after new information
arrives, at the cost of a lower volume of bene cial trades in each double auction.
Under stated conditions, the trading frequency that maximizes allocative efficiency coincides
with the information arrival frequency for scheduled information releases, but can
far exceed the information arrival frequency if new information arrives stochastically. A
simple calibration of the model suggests that a moderate market slowdown to the level
of seconds or minutes per double auction can improve allocative efficiency for assets with
relatively narrow investor participation and relatively infrequent news, such as small- and
micro-cap stocks.

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heterogeneous time preferences delegation trading frequency allocative eciency high-frequency trading double auction