Liquidity-Based Competition for Order Flow

Posted: 22 Sep 1998

See all articles by Duane J. Seppi

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business

Christine A. Parlour

University of California, Berkeley - Finance Group

Date Written: August 1998

Abstract

We present a microstructure model of competition between exchanges for order flow based on liquidity provision. Different pairings of pure limit order markets (PLM) and hybrid specialist/limit order markets (HM) are considered. We find that neither a pure nor a hybrid market structure is competition-proof. A PLM can always be supported in equilibrium as the dominant market (i.e., where the hybrid limit book is empty), but a HM can also be supported for some market parameterizations, as the dominant market. We also have examples of co-existence of competing markets. Order preferencing --- i.e., decisions about where orders are routed when investors are indifferent --- is a key determinant of market viability. Welfare comparisons show that competition between exchanges often, but not always, reduces the cost of liquidity.

JEL Classification: D4, G2, L1

Suggested Citation

Seppi, Duane J. and Parlour, Christine A., Liquidity-Based Competition for Order Flow (August 1998). Available at SSRN: https://ssrn.com/abstract=129816

Duane J. Seppi

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-2298 (Phone)
412-268-8896 (Fax)

Christine A. Parlour (Contact Author)

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
510-643-9391 (Phone)

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