Does the Prohibition of Trade-Through Hurt Liquidity Demanders?

31 Pages Posted: 24 Jul 2017

See all articles by Ningyuan Chen

Ningyuan Chen

University of Toronto at Mississauga - Department of Management; University of Toronto - Rotman School of Management

Steven Kou

Boston University

Date Written: July 19, 2017

Abstract

A particular rule of the Regulation National Market System (Reg NMS) established by the United States Securities and Exchange Commission, called the Order Protect Rule (OPR), generally prohibits any trade-through, which is defined to be a market order that is not executed at the best possible price among all trading venues. The benefit of such regulation to liquidity providers (those who place limit orders) is studied by Foucault and Menkveld (2008). We present a general model to study the potential impact of the regulation on liquidity demanders (those who place market orders). For a general limit order book model with multiple trading venues and stochastic market depths, we find that, although there are examples such that a liquidity demander can intentionally exploit trade-throughs to reduce the total execution cost and the average effective spread, the benefit is marginal for small trades and liquid stocks. This is consistent with empirical findings in Hendershott and Jones (2005).

Keywords: Optimal order execution, order routing, dynamic programming

Suggested Citation

Chen, Ningyuan and Kou, Steven, Does the Prohibition of Trade-Through Hurt Liquidity Demanders? (July 19, 2017). Available at SSRN: https://ssrn.com/abstract=3005835 or http://dx.doi.org/10.2139/ssrn.3005835

Ningyuan Chen (Contact Author)

University of Toronto at Mississauga - Department of Management ( email )


Canada

University of Toronto - Rotman School of Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada

Steven Kou

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
6173583318 (Phone)

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