Adverse Selection, Market Access and Inter-Market Competition
46 Pages Posted: 8 Mar 2013
Date Written: February 20, 2013
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: Suggested Citation