Cross-Venue Liquidity Provision: High Frequency Trading and Ghost Liquidity.

Summary We measure the extent to which consolidated liquidity in modern fragmented equity markets overstates true liquidity due to a phenomenon that we call Ghost Liquidity (GL). GL exists when traders place duplicate limit orders on competing venues, intending for only one of the orders to execute, and when one does execute, duplicates are cancelled. Employing data from 2013 for 91 stocks trading on their primary exchanges and three alternative platforms where order submitters are identified consistently across venues, we find that simply measured consolidated liquidity exceeds true consolidated liquidity due to the existence of GL. On average, for every 100 shares passively traded by a multi-market liquidity supplier on a given venue, around 19 shares are immediately cancelled by the same liquidity supplier on a different venue. Yet the average weight of GL in total consolidated depth, at around 4%, does not outweigh the liquidity benefits of fragmentation. GL is most pronounced for traders with a speed advantage such as high-frequency traders, in stocks exhibiting greater market fragmentation, in stocks where the tick is more likely to be binding, and on non-primary exchanges. Furthermore, GL decreases when the fraction of traders using smart order routing is large. Finally, we show that an increase in GL leads to the execution costs of slow and algo traders increasing, while those of HFTs are unaffected.