Market Quality and Contagion in Fragmented Markets
London School of Economics - Department of Finance; London School of Economics & Political Science (LSE) - Financial Markets Group
London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group
January 24, 2013
Financial market liquidity has become increasingly fragmented across multiple trading platforms. We propose an intuitive welfare-based market quality metric that can properly aggregate local market conditions across both securities and trading venues. Our analysis rests on a general equilibrium model with segmented markets. Arbitrageurs reap profits by effectively providing intermediation services (i.e. “liquidity”). Our market quality measure is equal to the additional consumption enjoyed by investors as a result of this intermediation, and can be represented by means of a number of observable proxies. The model is especially well-suited to study the contagion-like effects of liquidity shocks.
Number of Pages in PDF File: 37
Keywords: Fragmented markets, intermediation, arbitrage, liquidity, contagion
JEL Classification: G10, G20, D52, D53
Date posted: July 7, 2009 ; Last revised: January 25, 2013
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