Dynamic limit order placement activities and their effects on stock market quality

This study examines the interaction between dynamic limit order placement activities and market quality around the two system upgrades by the Australian Securities Exchange (ASX) which aims at reducing the latency of trades. We show that after the 2006 system upgrade from Stock Exchange Automated Trading System to Integrated Trading System, liquidity falls and short-term volatility heightens. Lower latency provides capacity for traders to position themselves to take liquidity when it is cheap. After the second upgrade in 2010 (launch of ASX Trade), the harmful effect reverses. Our evidence shows that in large-capitalisation stocks, algorithmic trading/high-frequency trading provides liquidity and stabilises the price when short-term volatility is high. Since we find that the market quality could be unfavourably affected after a system upgrade (i.e., the 2006 system upgrade), regulators need to be prepared for near-time reactions and rapid investigations in the event of market stress.