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Informed Trading and Maker-Taker Fees in a Low-Latency Limit Order Market

49 Pages Posted: 20 Nov 2012 Last revised: 6 Nov 2013

Michael Brolley

Wilfrid Laurier University

Katya Malinova

University of Toronto

Date Written: October 24, 2013

Abstract

We model a financial market where privately informed investors trade in a limit order book monitored by professional liquidity providers. Price competition between informed limit order submitters and professional market makers allows us to capture tradeoffs between informed limit and market orders in a methodologically simple way. We apply our model to study maker-taker fees --- a prevalent, but controversial exchange fee system that pays a maker rebate for liquidity provision and levies a taker fee for liquidity removal. When maker-taker fees are passed through to all traders, only the total exchange fee per transaction has an economic impact, consistent with previous literature. However, when investors pay only the average exchange fee through a flat fee per transaction --- as is common practice in the industry --- maker-taker fees have an impact beyond that of a change in the total fee. An increase in the maker rebate lowers trading costs, increases trading volume, improves welfare, but decreases market participation by investors.

Keywords: Maker-Taker Fees, Informed Trading, Low-Latency Trading, Limit Order Book

JEL Classification: G10, G14

Suggested Citation

Brolley, Michael and Malinova, Katya, Informed Trading and Maker-Taker Fees in a Low-Latency Limit Order Market (October 24, 2013). Available at SSRN: https://ssrn.com/abstract=2178102 or http://dx.doi.org/10.2139/ssrn.2178102

Michael Brolley (Contact Author)

Wilfrid Laurier University ( email )

Frank Peters Building
75 University Avenue
Waterloo, Ontario N2L 3C5
Canada

HOME PAGE: http://www.mikerostructure.com

Katya Malinova

University of Toronto ( email )

Department of Statistical Sciences
Toronto, Ontario M5S 3G8
Canada

HOME PAGE: http://individual.utoronto.ca/kmalinova/

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