Fragmentation and Algorithmic Trading: Joint Impact on Market Quality

45 Pages Posted: 1 Apr 2015 Last revised: 2 Apr 2015

See all articles by Michael J. Aitken

Michael J. Aitken

Macquarie Graduate School of Management

Drew Harris

University of New South Wales (UNSW)

Frederick H. deB. Harris

Wake Forest University; Capital Markets CRC Limited (CMCRC)

Date Written: March 30, 2015

Abstract

We investigate the effects of algorithmic trading and dark venues on U.S. security market quality. Market quality refers to the nearly universal mandate of securities regulators to ensure that all market design changes should not detract from efficiency or fairness which we define as less market manipulation. A simultaneous equations model is used to estimate how fragmentation of the lit and dark order flow interacts with algorithmic trading to determine round-trip transaction costs and end-of-day manipulation. We find that lit market fragmentation lowers effective spreads and reduces manipulation but that fragmentation into the dark raises effective spreads and increases manipulation.

Keywords: Algorithmic trading, dark trading, market manipulation, fragmentation

JEL Classification: GI8

Suggested Citation

Aitken, Michael J. and Harris, Drew and Harris, Frederick (Rick) H. deB., Fragmentation and Algorithmic Trading: Joint Impact on Market Quality (March 30, 2015). Available at SSRN: https://ssrn.com/abstract=2587314 or http://dx.doi.org/10.2139/ssrn.2587314

Michael J. Aitken

Macquarie Graduate School of Management ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Drew Harris

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

Frederick (Rick) H. deB. Harris (Contact Author)

Wake Forest University ( email )

2601 Wake Forest Road
Babcock Graduate School of Management
Winston-Salem, NC 27109
United States
336-758-5112 (Phone)

Capital Markets CRC Limited (CMCRC) ( email )

Level 3, 55 Harrington Street
Sydney, 2000
Australia

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