A model of broker's trading, with applications to order flow internalization

Sugato Chakravarty and Asani Sarkar

Review of Financial Economics, 2002, vol. 11, issue 1, 19-36

Abstract: Although brokers' trading is endemic in securities markets, the form of this trading differs between markets. Whereas in some securities markets, brokers may trade with their customers in the same transaction (simultaneous dual trading or SDT), in other markets, brokers are only allowed to trade after their customers in a separate transaction (consecutive dual trading or CDT). We show theoretically that informed and noise traders are worse off and brokers are better off while market depth is lower in the SDT market. Thus, given a choice, traders prefer fewer brokers in the SDT market compared to the CDT market. With free entry, however, market depth may be higher in the SDT market provided its entry cost is sufficiently low relative to the CDT market. We study order flow internalization by broker‐dealers, and show that, in the free entry equilibrium, internalization hurts retail customers and market quality.

Date: 2002
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https://doi.org/10.1016/S1058-3300(01)00031-3

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Persistent link: https://EconPapers.repec.org/RePEc:wly:revfec:v:11:y:2002:i:1:p:19-36

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