VOL. LXVI, NO. 1 • FEBRUARY 2011 | TERRENCE HENDERSHOTT, CHARLES M. JONES, and ALBERT J. MENKVELD*
The paper examines whether algorithmic trading (AT) improves market liquidity. Using the staggered introduction of automated quote dissemination on the New York Stock Exchange (NYSE) in 2003 as an exogenous instrument, the authors find that AT improves liquidity for large-cap stocks by narrowing spreads and reducing adverse selection. However, AT also increases realized spreads and other measures of liquidity supplier revenues, suggesting that liquidity providers capture some of the surplus. The findings indicate that AT enhances liquidity and the informativeness of quotes, but its effects on smaller-cap stocks are less clear due to weaker instruments. The study provides insights into the broader implications of AT on market quality and liquidity.The paper examines whether algorithmic trading (AT) improves market liquidity. Using the staggered introduction of automated quote dissemination on the New York Stock Exchange (NYSE) in 2003 as an exogenous instrument, the authors find that AT improves liquidity for large-cap stocks by narrowing spreads and reducing adverse selection. However, AT also increases realized spreads and other measures of liquidity supplier revenues, suggesting that liquidity providers capture some of the surplus. The findings indicate that AT enhances liquidity and the informativeness of quotes, but its effects on smaller-cap stocks are less clear due to weaker instruments. The study provides insights into the broader implications of AT on market quality and liquidity.