Adverse Selection, Market Access and Inter-Market Competition

46 Pages Posted: 8 Mar 2013

See all articles by Peter Hoffmann

Peter Hoffmann

European Central Bank (ECB) - Directorate General Research

Date Written: February 20, 2013

Abstract

We study the role of informed trading in a fragmented financial market under the absence of inter-market price priority. Due to frictions in traders’ market access, liquidity providers on alternative trading platforms may be exposed to an increased adverse selection risk. As a consequence, the main market dominates (offers better quotes) frequently albeit charging higher transaction fees. The empirical analysis of a dataset of trading in French and German stocks suggests that trades on Chi-X, a lowcost trading platform, carry significantly more private information than those executed in the Primary Markets. Consistent with our theory, we find a negative relationship between the competitiveness of Chi-X’s quotes and this excess adverse selection risk faced by liquidity providers in the cross-section. Our results have some implications for the design of best-execution policies.

Keywords: MiFID, Inter-market competition, adverse selection, transaction fees

JEL Classification: G10, G14, G24

Suggested Citation

Hoffmann, Peter, Adverse Selection, Market Access and Inter-Market Competition (February 20, 2013). ECB Working Paper No. 1519, Available at SSRN: https://ssrn.com/abstract=2221405

Peter Hoffmann (Contact Author)

European Central Bank (ECB) - Directorate General Research ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

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