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Internalization and Market Quality in a Fragmented Market Structure

Daniel G. Weaver

Rutgers Business School

May 19, 2011

According to the SEC, US stock trading venues now include 10 public exchanges, more than 30 dark pools, and more than 200 internalizing broker-dealers. A large proportion of the 30 dark pools now largely facilitate internalization by their owners. According to published reports, over three quarters of the order flow executed through dark pools is likely internalized. As the number of trading venues has increased, so too has the percentage of order flow executed off-exchange. Today, one third of NYSE volume and one quarter of NASDAQ volume is reported off-exchange and is largely internalized order flow. This paper examines the impact of this dramatic increase in internalization on market quality. I find, after controlling for factors known to be influential, that internalization is directly related to spread width (quoted, effective, and realized). I also find that the percentage of volume internalized is directly associated with price impact per trade and volatility.

Number of Pages in PDF File: 50

Keywords: Dark pool, internalization, market quality, fragmentation

JEL Classification: G12, G14, G18

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Date posted: May 25, 2011 ; Last revised: July 7, 2011

Suggested Citation

Weaver, Daniel G., Internalization and Market Quality in a Fragmented Market Structure (May 19, 2011). Available at SSRN: http://ssrn.com/abstract=1846470 or http://dx.doi.org/10.2139/ssrn.1846470

Contact Information

Daniel G. Weaver (Contact Author)
Rutgers Business School ( email )
94 Rockafeller Road
Piscataway, NJ 08854
United States
848.445.5644 (Phone)
732.445.2333 (Fax)
HOME PAGE: http://weaver.rutgers.edu
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