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I'm not implying that liquidity is binary. I'm implying that it does not scale linearly, but rather exponentially towards an asymptote. That is, you can add a

by hsitz 9y ago

I'm not implying that liquidity is binary. I'm implying that it does not scale linearly, but rather exponentially towards an asymptote. That is, you can add as much as you want, the total amount approaches a limit. Said a different way, with your "trading costs" substitution: If x amount of human effort is required to reduce trading costs from, say, 5% of a transaction to 0.001%, perhaps (let's assume) that's justified. But is it then wise for a society to encourage expenditure of 10x more effort just to reduce costs to 0.0001%? (This analogy doesn't really hold, because cost of trading could be 0 and there could still be 0 liquidity, just no other parties interested in buying or selling, but it still seems to point at a real issue when restricted to talking about liquidity.)

consz 9y ago
I think an interesting point you might consider -- let's suppose there is such a thing as "too much" liquidity, and as a corollary, there's a "perfect" amount of liquidity. What do you think happens when more liquidity than the perfect amount is introduced? I think a lot of arguments which support the idea of HFT being too much liquidity seem to take, as a premise, that the extra liquidity costs consumers -- namely, non-HFT participants in the market trading against the HFTs, the "buyers" of liquidity. Does it? If you have too much liquidity, doesn't that just mean that the buyers don't buy any of it? They saw as much liquidity as they needed, completed their trades, and went home. It seems like the actual cost of too much liquidity is HFT firms which send orders that don't get traded against, so they have no benefit (to the HFT), but still have a cost (the firm has to run, after all). Yes, there's some cost to society here, in the same way that there's a cost any time someone takes on a speculatively profitable business that turns out not to be. I'm sure there are some strong arguments you could make that HFTs are unnecessary, but the argument of "too much" liquidity always felt shaky to me (in part, because it's one of those arguments that relies on playing fast and loose with nebulous terms).
- ultraluminous 9y ago
  But he didn't argue we have "too much" liquidity. The argument is that we have "enough" liquidity and are now expending a huge volume of capital on a literally imperceptible increase in liquidity.
  - consz 9y ago
    My point is that I don't think it's a huge volume of capital. The extra wasted capital here is the cost of running an HFT firm while you test your strategy (aka. see if your liquidity is valuable or not) -- if it's not profitable, it's not a huge loss (HFT firms, in the grand scheme of things, are relatively small) and the firm shuts down; if it's profitable, then clearly they're trading against non-HFTs that value their liquidity, so what's the issue here?

by hsitz 9y ago

consz 9y ago

I think an interesting point you might consider -- let's suppose there is such a thing as "too much" liquidity, and as a corollary, there's a "perfect" amount of liquidity. What do you think happens when more liquidity than the perfect amount is introduced? I think a lot of arguments which support the idea of HFT being too much liquidity seem to take, as a premise, that the extra liquidity costs consumers -- namely, non-HFT participants in the market trading against the HFTs, the "buyers" of liquidity. Does it? If you have too much liquidity, doesn't that just mean that the buyers don't buy any of it? They saw as much liquidity as they needed, completed their trades, and went home. It seems like the actual cost of too much liquidity is HFT firms which send orders that don't get traded against, so they have no benefit (to the HFT), but still have a cost (the firm has to run, after all). Yes, there's some cost to society here, in the same way that there's a cost any time someone takes on a speculatively profitable business that turns out not to be. I'm sure there are some strong arguments you could make that HFTs are unnecessary, but the argument of "too much" liquidity always felt shaky to me (in part, because it's one of those arguments that relies on playing fast and loose with nebulous terms).

ultraluminous 9y ago
But he didn't argue we have "too much" liquidity. The argument is that we have "enough" liquidity and are now expending a huge volume of capital on a literally imperceptible increase in liquidity.
- consz 9y ago
  My point is that I don't think it's a huge volume of capital. The extra wasted capital here is the cost of running an HFT firm while you test your strategy (aka. see if your liquidity is valuable or not) -- if it's not profitable, it's not a huge loss (HFT firms, in the grand scheme of things, are relatively small) and the firm shuts down; if it's profitable, then clearly they're trading against non-HFTs that value their liquidity, so what's the issue here?