A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?

61 Pages Posted: 5 Jun 2019 Last revised: 23 Jul 2020

See all articles by Eric B. Budish

Eric B. Budish

University of Chicago - Booth School of Business

Robin S. Lee

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

John J. Shim

University of Notre Dame - Mendoza College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: July 22, 2020

Abstract

This paper builds a new model of financial exchange competition, tailored to the institutional details of the modern US stock market. In equilibrium, exchange trading fees are competitive but exchanges are able to earn economic profits from the sale of speed technology. We document stylized facts consistent with these results. We then use the model to analyze incentives for market design innovation. The novel tension between private and social innovation incentives is incumbents’ rents from speed technology in the status quo. This creates a disincentive to adopt new market designs that eliminate latency arbitrage and the high-frequency trading arms race.

Keywords: market design, innovation, financial exchanges, industrial organization, platform markets, high-frequency trading

JEL Classification: D02, D44, D47, D53, D82, G1,G2, G23, L1, L13, L5, L89

Suggested Citation

Budish, Eric B. and Lee, Robin S. and Shim, John J., A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market? (July 22, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2019-72, Chicago Booth: George J. Stigler Center for the Study of the Economy & the State Working Paper No. 46, Chicago Booth Research Paper No. 20-19, Initiative on Global Markets Paper No. 183, Available at SSRN: https://ssrn.com/abstract=3391461 or http://dx.doi.org/10.2139/ssrn.3391461

Eric B. Budish (Contact Author)

University of Chicago - Booth School of Business ( email )

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Robin S. Lee

Harvard University - Department of Economics ( email )

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Cambridge, MA 02138
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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John J. Shim

University of Notre Dame - Mendoza College of Business ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

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