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A tale of one exchange and two order books: Effects of fragmentation in the absence of competition

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

No 234, SAFE Working Paper Series from Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt

Abstract: Exchanges nowadays routinely operate multiple, almost identically structured limit order markets for the same security. We study the effects of such fragmentation on market performance using a dynamic model where agents trade strategically across two identically-organized limit order books. We show that fragmented markets, in equilibrium, offer higher welfare to intermediaries at the expense of investors with intrinsic trading motives, and lower liquidity than consolidated markets. Consistent with our theory, we document improvements in liquidity and lower profits for liquidity providers when Euronext, in 2009, consolidated its order flow for stocks traded across two country-specific and identically-organized order books into a single order book. Our results suggest that competition in market design, not fragmentation, drives previously documented improvements in market quality when new trading venues emerge; in the absence of such competition, market fragmentation is harmful.

Keywords: Fragmentation; Competition; Liquidity; Price Efficiency (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-mst
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
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