We have found significant evidence that the stability of NBBO spreads has decreased since the implementation of Reg NMS in March 2007. Combing through over 0.7 trillion quote and trade records, we sorted stocks into bins by the changes in NBBO spread every second of the trading day. We then plotted the results. You can clearly see the decline in NBBO stability since 2007 in general, and during very active trading. An unstable NBBO is a indication of a drop in liquidity, or that visible liquidity might be an illusion.
See also Part 1, The NBBO Spread and The Rise of the HFT Machines
Shows the percentage of stocks during each second that had changes in the NBBO spread greater (flutter) than 0 to 25 cents. The percentage of stocks with NBBO flutter greater than 0 cents is plotted in dark violet. The percentage of stocks with NBBO flutter greater than 1 cent is plotted in a light violet, and so on up to the percentage of stocks with NBBO flutter greater than 25 cents which is plotted in red. Lower values equate to more stable NBBO spreads. Note the jump (meaning less stable spreads) after Reg NMS was implemented (March 2007), which overall remains persistent through today. Also note the significant increase in flutter around news and other events such as the flash crash (5/6/2010) and August 2011.
X-Axis shows time of day (Eastern Time)