Middlemen in Limit Order Markets

Abstract

Exchanges operate limit-order markets where non-synchronous investors can trade.  An early investor can leave a price quote for a late investor to consume.  High-tech, informed middlemen entered these markets in the last two decades.  Naturally, one expects better informed middlemen to hurt gains from trade (i.e., welfare), because they adversely select investor quotes.  But, might they raise welfare as market makers who quickly refresh quotes on incoming information?  And, as market makers, they offer investors the option to temporarily park their asset.  We offer a model with all these features and calibrate it to study how middlemen affect welfare.

Keywords: high-frequency trading, welfare, liquidity, middleman

JEL Classification: G00