The Quote Exception Rule: Giving High Frequency Traders an Unintended Advantage

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The U.S. Securities and Exchange Commission’s Rule 611 allows trades on exchanges that have not matched the new NBBO to be executed at the old NBBO for one second. This exception to rules typically preventing trade throughs may allow fast traders, who see the new NBBO before slower traders, to take advantage of their speed. We document trading behavior consistent with such actions and estimate that in 2008 this rule allowed fast traders to earn revenue of more than $233 million per year at the expense of the slow traders. Furthermore, we show that when the NYSE decreased latency by 600 milliseconds on March 10, 2008, execution quality improved markedly for fast liquidity demanders, but improved only minimally for slow liquidity demanders. However, there was a decrease in volume executed at adverse prices, indicating that slow traders adopt strategies to avoid trading with fast traders.