Market Power on Exchanges: Linking Price Impact to Trading Fees

Sarah Draus

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: Recent regulations, aimed at making trading and exchange services more competitive, triggered the proliferation of competing trading venues and resulted in high order flow fragmentation. This paper demonstrates that fragmentation allows liquidity providers and exchanges to retain market power. Whenever exchanges are not completely liquid, a rational trader fragments his order to reduce price impact. This lowers the price elasticity of both liquidity provider’s asset demand and exchange trading volume, inducing mark-ups on transaction prices and on exchange trading fees. Surprisingly, less competitive liquidity provision feeds back into higher trading fees. Moreover, exchanges with better liquidity charge higher trading fees and attract larger market shares. The results are consistent with anecdotal evidence and deliver empirical implications for the effect of introducing exchange competition on implicit and explicit trading costs.

Keywords: stock exchanges; competition; order fragmentation; trading fee; liquidity; regulation. (search for similar items in EconPapers)
JEL-codes: G18 G20 L10 (search for similar items in EconPapers)
Date: 2012-05-04
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Persistent link: https://EconPapers.repec.org/RePEc:sef:csefwp:490

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