Trading in Fragmented Markets
Journal of Financial and Quantitative Analysis, Vol. 56, No. 1 (February 2021), pp. 93–121.
75 Pages Posted: 22 May 2016 Last revised: 14 Jan 2021
Date Written: September 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 opposing 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% lower.
Keywords: exchange competition, fragmenation, high-frequency trading, liquidity, bid-ask spread
JEL Classification: D43, D47, G18
Suggested Citation: Suggested Citation