Imperfect Competition in Financial Markets: An Empirical Study of Island and Nasdaq

Bruno Biais, Christophe Bisière and Chester Spatt ()
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Chester Spatt: Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213

Management Science, 2010, vol. 56, issue 12, 2237-2250

Abstract: The competition between Island and Nasdaq at the beginning of the century offers a natural laboratory to study competition between and within trading platforms and its consequences for liquidity supply. Our empirical strategy takes advantage of the difference between the pricing grids used on Island and Nasdaq, as well as of the decline in the Nasdaq tick. Using the finer grid prevailing on their market, Island limit order traders undercut Nasdaq quotes, much more than they undercut one another. The drop in the Nasdaq tick size triggered a drop in Island spreads, despite the Island tick already being very thin before Nasdaq decimalization. We also estimate a structural model of liquidity supply and find that Island limit order traders earned rents before Nasdaq decimalization. Our results suggest that perfect competition cannot be taken for granted, even on transparent open limit order books with a very thin pricing grid.

Keywords: competition in financial markets; liquidity supply; trading mechanisms; different tick sizes (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (25)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:56:y:2010:i:12:p:2237-2250

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