Adverse selection, market access and inter-market competition

Peter Hoffmann

No 1519, Working Paper Series from European Central Bank

Abstract: We study the role of informed trading in a fragmented financial market under the absence of inter-market price priority. Due to frictions in traders’ market access, liquidity providers on alternative trading platforms may be exposed to an increased adverse selection risk. As a consequence, the main market dominates (offers better quotes) frequently albeit charging higher transaction fees. The empirical analysis of a dataset of trading in French and German stocks suggests that trades on Chi-X, a lowcost trading platform, carry significantly more private information than those executed in the Primary Markets. Consistent with our theory, we find a negative relationship between the competitiveness of Chi-X’s quotes and this excess adverse selection risk faced by liquidity providers in the cross-section. Our results have some implications for the design of best-execution policies. JEL Classification: G10, G14, G24

Keywords: adverse selection; Inter-market competition; MiFID; Transaction fees (search for similar items in EconPapers)
Date: 2013-03
New Economics Papers: this item is included in nep-cta and nep-mst
Note: 1137913
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20131519

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