High-Frequency Trade and Market Performance ∗

High-frequency trading has transformed financial markets in recent years. We study the consequences of this development using a model with multiple trading venues, costly information acquisition, and several types of traders. An increase in trading speed crowds out information acquisition by reducing the gains from trading against mispriced quotes. Thus, faster speeds have two effects on traditional measures of market performance. First, the bid-ask spread declines, since there are fewer informational asymmetries. Second, price efficiency deteriorates, since less information is available to be incorporated into prices. A general tradeoff exists between low spreads and price efficiency. We characterize the frontier of this tradeoff and evaluate several trading mechanisms within this framework. The prevalent limit order book mechanism generally does not induce outcomes on this frontier. We consider two alternatives: first, a small delay added to the processing of all orders except cancellations, and second, frequent batch auctions. Both induce equilibrium outcomes on this frontier. ∗We are indebted to our advisors Timothy Bresnahan, Gabriel Carroll, Jonathan Levin, Monika Piazzesi, and Paul Milgrom. We would also like to thank Sandro Ambuehl, Eric Budish, Darrell Duffie, Liran Einav, Joseph Grundfest, Terrence Hendershott, Fuhito Kojima, Muriel Niederle, Alvin Roth, Ilya Segal, Andrzej Skrzypacz, and seminar participants at Stanford, as well as various industry experts for valuable comments. We acknowledge financial support by the Kohlhagen Fellowship Fund and the Kapnick Fellowship Program through grants to the Stanford Institute for Economic Policy Research. Mailing address: Stanford University Economics Department, 579 Serra Mall, Stanford, CA 94305. Email: baldauf@stanford.edu (Baldauf), jmollner@stanford.edu (Mollner).