The Demise of the NYSE and NASDAQ: Market Quality in the Age of Market Fragmentation

Abstract

U.S. equity exchanges have experienced a dramatic increase in competition from new entrants, resulting in the fragmentation of trading across venues. While market quality has generally improved over this period, we show most of the improvements have accrued to the largest stocks. We then show this bifurcation in market quality is related to the fragmentation of trading. Theoretically, more exchange competition should reduce trading costs, yet it may also increase adverse selection for liquidity providers, leading to higher spreads. We document evidence of both effects -- fragmentation improves market quality for large stocks while small stocks experience relatively worse quality.

Keywords: Exchange competition, fragmentation, liquidity, market microstructure

JEL Classification: G12, G14