Competition for Order Flow and Smart Order Routing Systems

Thierry Foucault and Albert Menkveld

No 5523, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study changes in liquidity following the introduction of a new electronic limit order market when, prior to its introduction, trading is centralized in a single limit order market. We also study how automation of routing decisions and trading fees affect the relative liquidity of rival markets. The theoretical analysis yields three main predictions: (i) consolidated depth is larger in the multiple limit order markets environment, (ii) consolidated bid-ask spread is smaller in the multiple limit order markets environment and (iii) the liquidity of the entrant market relative to that of the incumbent market increases with the level of automation for routing decisions (the proportion of 'smart routers'). We test these predictions by studying the rivalry between the London Stock Exchange (entrant) and Euronext (incumbent) in the Dutch stock market. The main predictions of the model are supported.

Keywords: Market fragmentation; Centralized limit order book; Smart routers; Trading fees; Trade-throughs (search for similar items in EconPapers)
JEL-codes: G10 G18 G24 L13 (search for similar items in EconPapers)
Date: 2006-03
New Economics Papers: this item is included in nep-cba, nep-fin and nep-fmk
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Citations: View citations in EconPapers (10)

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Related works:
Working Paper: Competition for Order Flow and Smart Order Routing Systems (2010)
Journal Article: Competition for Order Flow and Smart Order Routing Systems (2008)
Working Paper: Competition for Order Flow and Smart Order Routing Systems (2008)
Working Paper: Competition for order flow and smart order routing systems (2006)
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