Can a rainstorm in Cleveland make markets more liquid?

Ever since HFTs rose to prominence, a debate has raged over whether the ensuing arms race between super-fast traders helped or hindered markets.  One side argues that the fastest traders reduce the spreads between bids and offers.  Critics counter that, in reality, spreads widen since slower traders need to charge higher spreads as insurance against getting caught flat-footed by a fast-moving event.

Andriy Shkilko and Konstantin Sokolov of Wilfrid Laurier University believe the critics of HFTs are correct.  How did they reach their conclusion?

Starting in 2010, HFTs began using ultrafast microwave links to relay prices and other info between Chicago and New York. To begin with, only some traders had access to microwave networks. Until 2013, others had to rely on less speedy fiber-optic cable.

 

But microwave transmissions are disrupted by water droplets and snowflakes, so during heavy storms traders using the networks switch to fiber, Shkilko and Sokolov used weather-station data from along the microwaves’ paths to determine when storms occurred and then looked at what happened to bid-ask spreads in a variety of securities during those periods.

 

They narrowed, suggesting that the slowing down of the fastest high-frequency traders improved market liquidity.