A Tale of Two Cities - Inter-Market Latency, Market Integration, and Market Quality

We study the introduction of a microwave link between Frankfurt and London and identify its effects on German stocks that trade in both locations using French firms that trade only in London as the control group. We find that the link improves the integration between the two markets as evidenced by a reduction in arbitrage opportunities. The effects on market quality differ across stocks as high-frequency traders strategically utilize their speed advantage to supply or consume liquidity. In London, mid cap stocks benefit from increased liquidity provision whereas order flow for large stocks becomes more toxic. London's increased competitiveness for mid cap stocks also translates into an increase in its information share, while the information shares of large cap stocks are unchanged. These results suggest that market integration differently affects investors based on their speed advantage, trading venues based on their level of competitiveness, and stocks based on their size.