We examine these effects by studying a series of exogenous weather episodes that temporarily remove the speed advantages of the fastest traders by disrupting their microwave networks. The disruptions are associated with lower adverse selection and lower trading costs. In additional analysis, we show that the long-term removal of speed differentials results in similar effects and also increases gains from trade.
In the main analysis, we examine liquidity when heavy precipitation dis-rupts microwave transmissions between Chicago and New York. During our 2011 through 2012 sample period, traders send information between the two cities via either a fiber optic cable or a microwave network. The microwave net-works, which are about 30% faster than the cable, have two important char-acteristics. First, only a small group of trading firms has access to them, and these firms engage in constant competition for the top speed by retrofitting con-tinuously. Second, precipitation (i.e., rain and snow) disrupts them. The first characteristic creates a speed advantage for select traders, whereas the second characteristic occasionally removes this advantage. We show that when the microwave speed advantage is removed, adverse selection and trading costs decline by up to 6.7% and 5.2%, respectively.
To confirm that precipitation does indeed serve as a shock to information transmission speeds, we show that equities in New York react to futures sig-nals from Chicago two milliseconds slower when it rains or snows. During our sample period, two milliseconds is precisely the difference between the mi-crowave and fiber optic transmission speeds.
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