The Effects of High-frequency Anticipatory Trading: Small Informed Trader vs. Round-Tripper

Paper: arXiv 2304.13985

Authors: Ziyi Xu, Xue Cheng

Abstract

In an extended Kyle’s model, the interactions between a large informed trader and a high-frequency trader (HFT) who can anticipate the former’s incoming order are studied. We find that, in equilibrium, HFT may play the role of Small-IT or Round-Tripper: both of them trade in the same direction as IT in advance, but when IT’s order arrives, Small-IT continues to take liquidity away, while Round-Tripper supplies liquidity back. So Small-IT always harms IT, while Round-Tripper may benefit her. What’s more, with an anticipatory HFT, normal-speed small uninformed traders suffer less and price discovery is accelerated.

Complexity vs Empirical Score

• Math Complexity: 8.5/10
• Empirical Rigor: 2.0/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: This paper presents a strong theoretical extension of Kyle’s model to analyze high-frequency anticipatory trading dynamics. While highly mathematical and rigorous in its formal proofs, it lacks empirical validation and backtesting with real market data.

Research Flowchart

  flowchart TD
    A["Research Goal: Analyze HFT Anticipatory Trading Effects on Informed Traders & Market Quality"] --> B["Methodology: Extended Kyle's Sequential Equilibrium Model"]
    B --> C["Inputs: Large IT Orders, HFT Signal Anticipation, Noise Trader Orders"]
    C --> D["Computational Process: Solve Equilibrium Trading Strategies & Price Impact"]
    D --> E1["Outcome 1: HFT as 'Small-IT' Continues Directional Trading (Harms IT)"]
    D --> E2["Outcome 2: HFT as 'Round-Tripper' Reverses Trade to Supply Liquidity (May Benefit IT)"]
    D --> F["Market Impact: Uninformed Traders Suffer Less & Price Discovery Accelerates"]