Imperfect Competition in Financial Markets: Island vs NASDAQ
40 Pages Posted: 23 Nov 2003
Date Written: November 26, 2003
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 Classification: G10, G23
Suggested Citation: Suggested Citation
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