Which hat fits best: High Frequency Traders acting as Designated Market Makers

Authors: Mario Bellia (Goethe University)

Title: Which hat fits best: High Frequency Traders acting as Designated Market Makers

Abstract: This paper examines the role of High Frequency Traders (HFTs) as Designated Market Makers. By using data provided by the Base Europeenne de Donnees Financieres a Haute Frequence (BEDOFIH) on the Euronext market, which includes both HFT and account type identifiers, I examine the liquidity provision, the trading behavior and the risk of being picked-off by other traders. I find that HFT Designated Market Makers (HFT-DMMs) are the most prominent liquidity providers among the other designated market makers in gross terms. However, they also consume a significant part of the liquidity, so that the final net liquidity provision is close to zero. They act strategically, exploiting temporary imbalances especially when the bid-ask spread is wider. HFT-DMMs prefer to provide liquidity to slow traders, and are most likely to be picked-off by other HFT-DMMs.