Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk

Alejandro Bernales, Nicolás Garrido, Satchit Sagade, Marcela Valenzuela and Christian Westheide

No 234, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.

Keywords: Fragmentation; Competition; Liquidity; Price Efficiency (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2020, Revised 2020
New Economics Papers: this item is included in nep-cfn and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:234

DOI: 10.2139/ssrn.3276548

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