Abstract

This paper studies market activity in the ?millisecond environment,? where computer

algorithms respond to each other almost instantaneously. Using order-level NASDAQ

data, we find that the millisecond environment consists of activity by some traders who

respond to market events (like changes in the limit order book) within roughly 2-3 ms,

and others who seem to cycle in wall-clock time (e.g. access the market every second).

We define low-latency activity as strategies that respond to market events in the

millisecond environment, the hallmark of proprietary trading by a variety of players

including electronic market makers and statistical arbitrage desks. We construct a

measure of low-latency activity by identifying ?strategic runs,? which are linked

submissions, cancellations, and executions that are likely to be parts of a dynamic

strategy. We use this measure to study the impact that low-latency activity has on market

quality both during normal market conditions and during a period of declining prices and

heightened economic uncertainty. Our conclusion is that increased low-latency activity

improves traditional market quality measures such as short-term volatility, spreads, and

displayed depth in the limit order book.