| Using trader-identified transaction data from the Commodity Futures Trading Commission, I shed light on heterogeneity and interactions within the intermediation sector. Market maker "speed" differences generate long sequences of intermediaries separating terminal sellers and buyers of assets. Empirically, assets flow from liquidity supplying high frequency traders (HFTs) to slower market makers by symbiotic risk sharing. HFTs specialize in new intermediation, whereas slower market makers specialize in absorbing their price risk. I rationalize these results in a model of an intermediation hierarchy in which speed differences and order flow predictability enable fast market makers to select their counterparties. Under conditions, speed heterogeneity within the market-making sector increases short-run aggregate liquidity, but diminishes long-run aggregate liquidity through a speed arms race. Furthermore, counterparty selection resolves the puzzle of high HFT compensation for small execution time improvements and plays an important role in the evaluation of several proposed HFT regulations. |
