The Impact of co-location of securities exchanges’ and traders’ computer servers on market liquidity

This study examines the impact of allowing traders to co-locate their servers near exchange servers on the liquidity of futures contracts traded on the Australian Securities Exchange. It provides some evidence of an increase in proxies for HFT activity following the introduction of colocation including raw message traffic, order to trade ratios and the volume associated with message traffic to trading volume. The paper also provides strong evidence of a decrease in bid ask spreads and an increase in market depth after the introduction of co-location. We conclude that the introduction of co-location enhances liquidity. Furthermore, this improvement in liquidity is not dependent on an increase in HFT activity. We conjecture that colocation improves the efficiency with which liquidity providers (including market maker HFTs) are able to make markets. We also provide estimates of the value of the improvement in liquidity to the broader market.