Does the Prohibition of Trade-Through Hurt Liquidity Demanders?

Abstract

The Order Protect Rule (OPR) in the U.S. generally prohibits any trade-through, i.e., a market order that is not executed at the best possible price among fast (electronic and automated) trading venues. By deriving upper and lower bounds for the difference in the execution costs in a dynamic model, we find that although trade-through allows for flexible trading strategies and may benefit the liquidity demander, the benefit is insignificant in most cases, especially for small trades and stocks with fast resilience. Therefore, considering other benefits of the OPR studied in the literature, this study supports the regulation and suggests that the current separate regulations for fast and slow venues may be extended to differentiate stocks with fast and slow resilience speeds.

Keywords: Optimal order execution, order routing, dynamic programming