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Imperfect Competition in Financial Markets: Island vs Nasdaq
Bruno Biais Centre for Economic Policy Research (CEPR) Christophe Bisiere Universite de Toulouse - (IDEI - CRG) Chester S. Spatt Carnegie Mellon University - David A. Tepper School of Business November 26, 2003 14th Annual Utah Winter Finance Conference Paper; AFA 2004 San Diego Meetings; EFA 2002 Berlin Meetings Presented Paper Abstract: The Internet technology reduces the cost of transmitting and exchanging information. ECNs exploit this opportunity to enable investors to place quotes at very little cost and compete with incumbent stock exchanges. Does this quasi-free entry situation lead to competitive liquidity supply? We analyze trades and order book dynamics on Nasdaq and Island. The Nasdaq touch is frequently undercut by Island limit orders, using the finer tick size prevailing on that ECN. Before decimalization, the coarse tick size constrained Nasdaq spreads, and undercutting Island limit order traders earned oligopoly rents. After decimalization, the hypothesis that liquidity suppliers do not earn rents cannot be rejected.
Keywords: financial markets, liquidity supply, ECN, Island, NASDAQ JEL Classifications: G10, G23 Working Paper SeriesDate posted: November 23, 2003 ; Last revised: August 25, 2004Suggested CitationContact Information
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