Imperfect Competition in Financial Markets: Island vs NASDAQ

40 Pages Posted: 23 Nov 2003

See all articles by Bruno Biais

Bruno Biais

Centre for Economic Policy Research (CEPR)

Christophe Bisiere

Universite de Toulouse - (IDEI - CRG)

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business

Date Written: November 26, 2003

Abstract

The Internet technology reduces the cost of transmitting and exchanging information. ECNs exploit this opportunity to enable investors to place quotes at very little cost and compete with incumbent stock exchanges. Does this quasi-free entry situation lead to competitive liquidity supply? We analyze trades and order book dynamics on Nasdaq and Island. The Nasdaq touch is frequently undercut by Island limit orders, using the finer tick size prevailing on that ECN. Before decimalization, the coarse tick size constrained Nasdaq spreads, and undercutting Island limit order traders earned oligopoly rents. After decimalization, the hypothesis that liquidity suppliers do not earn rents cannot be rejected.

Keywords: financial markets, liquidity supply, ECN, Island, NASDAQ

JEL Classification: G10, G23

Suggested Citation

Biais, Bruno and Bisiere, Christophe and Spatt, Chester S., Imperfect Competition in Financial Markets: Island vs NASDAQ (November 26, 2003). 14th Annual Utah Winter Finance Conference Paper; AFA 2004 San Diego Meetings; EFA 2002 Berlin Meetings Presented Paper. Available at SSRN: https://ssrn.com/abstract=302398 or http://dx.doi.org/10.2139/ssrn.302398

Bruno Biais

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Christophe Bisiere (Contact Author)

Universite de Toulouse - (IDEI - CRG) ( email )

Manufacture des Tabacs
21 Allee de Brienne bat. F
Toulouse Cedex, F-31000
France

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-8834 (Phone)
412-268-6689 (Fax)

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