Trading in Fragmented Markets
78 Pages Posted: 22 May 2016 Last revised: 7 Feb 2019
Date Written: February 5, 2019
We study fragmentation of equity trading using a model of imperfect competition among exchanges. In the model, increased competition drives down trading fees. However, additional arbitrage opportunities arise in fragmented markets, intensifying adverse selection. These op- posing forces imply that the effects of fragmentation are context-dependent. To empirically investigate the ambiguity in a single context, we estimate key parameters of the model with order-level data for an Australian security. At the estimates, the benefits of increased competition are outweighed by the costs of multi-venue arbitrage. Compared to the prevailing duopoly, we predict the counterfactual monopoly spread to be 23 percent lower.
Keywords: exchange competition, fragmenation, high-frequency trading, liquidity, bid-ask spread
JEL Classification: D43, D47, G18
Suggested Citation: Suggested Citation