We show that High Frequency Traders (HFTs) are not necessarily beneficial to the stock market during flash crashes. They actually might consume liquidity when it is most needed, even when they are rewarded by the exchange to provide immediacy. This behavior exacerbates the transient price impact, unrelated to fundamentals, typically observed during a flash crash. In these instances, slow traders provide liquidity instead of HFTs, taking advantage of the discounted price. We thus uncover a trade-off between the greater liquidity and efficiency provided by HFTs in normal times, and the disruptive consequences of their quoting/trading activity during distressed times.
SAFE Working Paper No. 270