Trading Fees and Efficiency in Limit Order Markets

68 Pages Posted: 26 May 2011

See all articles by Jean-Edouard Colliard

Jean-Edouard Colliard

HEC Paris - Finance Department

Thierry Foucault

HEC Paris - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: May 2011

Abstract

We study competition between a dealer (OTC) market and a limit order market. In the limit order market, investors can choose to be "makers" (post limit orders) or "takers" (hit limit orders) whereas in the dealer market they must trade at dealers' quotes. Moreover, in the limit order market, investors pay a trading fee to the operator of this market ("the matchmaker"). We show that an increase in the matchmaker's trading fee can raise investors' ex-ante expected welfare. Actually, it induces makers to post more aggressive offers and thereby it raises the likelihood of a direct trade between investors. For this reason as well, a reduction in the matchmaker's trading fee can counter-intuitively raise the OTC market share. However, entry of a new matchmaker results in an improvement in investors' welfare, despite its negative effect on trading fees. The model has testable implications for the effects of a change in trading fees and their breakdown between makers and takers on various measures of market liquidity.

Keywords: inter-market competition, Limit order markets, liquidity, make/take fees, OTC markets, trading fees

JEL Classification: G00, G18, G20, L10

Suggested Citation

Colliard, Jean-Edouard and Foucault, Thierry, Trading Fees and Efficiency in Limit Order Markets (May 2011). CEPR Discussion Paper No. DP8395. Available at SSRN: https://ssrn.com/abstract=1853124

Jean-Edouard Colliard (Contact Author)

HEC Paris - Finance Department ( email )

France

Thierry Foucault

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
(33)139679569 (Phone)
(33)139677085 (Fax)

HOME PAGE: http://thierryfoucault.com/

Register to save articles to
your library

Register

Paper statistics

Downloads
8
Abstract Views
1,089
PlumX Metrics