Priority Rules

Abstract

While regulators often mandate price priority across markets, they do not impose
secondary priority rules. Order preferencing by a broker to a specific market may then
serve as tiebreaker. We compare order preferencing, modeled as price-broker-time priority (PBT), to price-time priority (PT). The secondary priority rule determines a limit
order’s execution probability, and hence investors’ choice between limit and market orders. When the tick is tight relative to the dispersion in investors’ valuations, trading
rates are higher with PBT whereas investor welfare is higher with PT. The opposite
holds for wide ticks. Our model has empirical and regulatory implications regarding
market fragmentation.

Keywords: Limit order markets, Trading Protocols, Time Priority, Welfare

JEL Classification: G00, G10, G11, G18