The role of internet quality on market liquidity and trading costs

In this project, we investigate the effects of internet speed differentials on stock market liquidity and gains from trading. Modern stock markets are characterized by competition on speed differential among traders in order to gain advantage over other rivals. Consequently, internet quality may affect stock market liquidity and trading costs. In this study, we have processed large trade and quote dataset, which contains intraday transactions data (trades and quotes) in nanoseconds timestamps, as well as trillions of real-time internet quality data. The data set combines information from two sources. The first is a set of scans in which every IP address is periodically probed to see how long it takes for the data to be transmitted round trip between the IP address and the server. The second is a commercial database of IP geolocations which reveals the location of each device. Together they produce a vast database covering Internet speed every 15 minutes between 2018 and 2019 in USA.

In literature, the effects of speed differentials on market quality are ambiguous. On one hand, speed may reduce adverse selection and inventory costs faced by liquidity providers, which contributes to improving liquidity. On the other hand, fast traders taking advantage of speed may take liquidity, which may have the opposite impact. Our empirical analysis will help to disentangle the theoretical predictions and contribute to the ongoing debates in literature.

Research questions

  • Does internet quality affect stock market liquidity and trading costs and in what direction?
  • Do the speed differentials affect stock market liquidity and trading costs both in low frequency and high frequency?
  • What drives the effect of speed differentials on stock market liquidity and trading costs?
  • How can we build investment strategy to gain from speed differentials?