Abstract

We examine how market makers with high-frequency trading (HFT-MM) react to asymmetric information and how they influence market liquidity. We propose the extension of the market microstructure model of Cespa and Vives (2022a) with the addition of the private information provided by liquidity consumers. In the equilibrium, the HFT-MM contributes to the increase of market liquidity by reflecting the private information of liquidity consumers into the market; however, if the precision of the private information is not stable during the different periods, the market liquidity deteriorates because the HFT-MM avoids the inventory risk. This liquidity deterioration is worse when the population ratio of HFT-MM is larger. This is a joint with Katsumasa Nishide.