Trading Fast and Slow: Colocation and Liquidity

We exploit an optional colocation upgrade at NASDAQ OMX Stockholm to assess how speed affects market liquidity. Liquidity improves for the overall market and even for non-colocated trading entities. We find that the upgrade is pursued mainly by market-maker-type participants. Those that upgrade use their enhanced speed to reduce their exposure to adverse selection and to relax their inventory constraints. In particular, the upgraded trading entities remain competitive at the best bid and offer even when they are inventory constrained. Our results suggest that increasing the speed of market making participants can have benefits for market liquidity

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