The speed premium: high-frequency trading and the cost of capital
Summary
Focus
We study how high-frequency trading (HFT) – the use of advanced technology to trade at lightning speed – affects the cost of capital that firms pay to finance their activities. While HFT is often credited with improving market liquidity, its broader impact on the real economy is less clear. To look at external shocks, we analyse two NASDAQ technological upgrades that increased HFT activity but were unrelated to company fundamentals. By comparing NASDAQ firms with matched firms on the New York Stock Exchange, we identify the causal effect of HFT on financing costs. We confirm our results by using the Stock Exchange of Hong Kong as an out-of-sample robustness test.
Contribution
Our paper moves the debate on HFT beyond specific analysis of market quality, such as spreads or volatility, to its real economic impact. The cost of capital is a key link between financial markets and the economy: it shapes how much companies must pay to finance investment, which drives jobs, growth and productivity. Earlier studies focused mainly on HFT's effects on traders and short-term market quality, while little was known about how HFT affects companies. We show that HFT impacts the real economy through two main channels: depending on the specific characteristics of the underlying stocks it can increase systematic risk and it can improve liquidity. By showing that the effects vary with stock characteristics, we provide insights for policymakers, corporate managers, investors and researchers.
Findings
We find that HFT has a dual impact on firms' cost of capital. For low-risk (low-beta) stocks, HFT raises financing costs by making them move more closely with the overall market, thereby amplifying systematic risk. By contrast, for the most liquid stocks, HFT lowers financing costs by reducing the liquidity premium demanded by investors. On balance, the risk-increasing channel dominates – HFT raises the cost of capital on average. To verify that our results are not driven by market fragmentation, rather than HFT per se, we conduct a complementary analysis of the Stock Exchange of Hong Kong – a large unfragmented market. This analysis confirms the patterns. Overall, our results show that the benefits and costs of HFT are unevenly distributed, raising questions about whether access to speed advantages should depend on stock characteristics rather than be applied universally.
Abstract
When trading in financial markets reaches light speed, does the real economy slow down? Using co-location and latency improvement upgrades at NASDAQ as natural experiments, we find that, on average, high frequency trading (HFT) leads to higher cost of capital. However, the impact is not uniform. HFT raises the cost of capital for low-beta stocks by amplifying their systematic risk, as HFT's correlated trading strategies make these stocks more responsive to market-wide information. For the most liquid stocks, HFT reduces the cost of capital by lowering the liquidity premium required by investors. A complementary test using data from the unfragmented Hong Kong market shows that these causal effects are not due to market fragmentation and persist across countries and market structures. Our results demonstrate that HFT's real economic effects are heterogeneous across stock characteristics, with important implications for financial market regulation and policy design.
JEL classification: G12, G14, G15
Keywords: high frequency trading, cost of capital, financial innovation, liquidity, systematic risk
