Once Upon a Broker Time? Order Preferencing and Market Quality
65 Pages Posted: 29 May 2018
Date Written: October 1, 2017
We develop a dynamic, inﬁnite horizon, microstructure model to study how priority rules determine market quality and investor welfare. We compare order preferencing, modeled as price-broker-time priority (PBT), to price-time priority (PT). Priority rules impact investors’ choice between limit and market orders. When the tick is tight, trading rates are higher with PBT whereas investor welfare is higher with PT. The opposite holds for a wide tick. PBT endogenously results when brokers individually choose between PT or PBT. Our model has testable implications regarding systematic patterns in order ﬂow, market depth, trade composition, and market fragmentation.
Keywords: Limit order markets, Trading Protocols, Time Priority, Welfare
JEL Classification: G00, G10, G11, G18
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