Liquidity Cycles and Make/Take Fees in Electronic Markets

Foucault, Thierry; Kadan, Ohad; Kandel , Eugene

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Liquidity Cycles and Make/Take Fees in Electronic Markets

CEPR Discussion Paper No. DP7551

50 Pages Posted: 11 Jan 2010

See all articles by Thierry Foucault

Ohad Kadan

Washington University in St. Louis - John M. Olin Business School

Eugene Kandel

Hebrew University of Jerusalem - Department of Economics; Centre for Economic Policy Research (CEPR)

There are 2 versions of this paper

Date Written: November 2009

Abstract

We develop a dynamic model of a market with two specialized sides: traders posting quotes ("market makers") and traders hitting quotes ("market takers"). Traders monitor the market to seize profit opportunities, generating high frequency liquidity cycles. Monitoring decisions by market-makers and market-takers are self-reinforcing, generating multiple equilibria with differing liquidity levels and duration clustering. The trading rate is typically maximized when makers and takers are charged different fees or even paid rebates. The model yields several empirical implications regarding the determinants of make/take fees, the trading rate, the bid-ask spread, and the effects of algorithmic trading on liquidity and welfare.

Keywords: algorithmic trading, duration clustering, Liquidity, make/take fees, monitoring, two-sided markets

JEL Classification: G12, G20, L14

Suggested Citation: Suggested Citation

Foucault, Thierry and Kadan, Ohad and Kandel, Eugene, Liquidity Cycles and Make/Take Fees in Electronic Markets (November 2009). CEPR Discussion Paper No. DP7551, Available at SSRN: https://ssrn.com/abstract=1533137