Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk

88 Pages Posted: 5 Nov 2018 Last revised: 4 Aug 2022

See all articles by Alejandro Bernales

Alejandro Bernales

Universidad de Chile

Nicolás Garrido

University of Chile

Satchit Sagade

Nasdaq, Inc.; Leibniz Institute for Financial Research SAFE

Marcela Valenzuela

Pontificia Universidad Católica de Chile

Christian Westheide

University of Vienna - Department of Finance

Date Written: August 2022

Abstract

By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare
differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.

Keywords: Fragmentation, Competition, Liquidity, Price Efficiency, Picking-Off Risk

JEL Classification: G10, G12

Suggested Citation

Bernales, Alejandro and Garrido, Nicolás and Sagade, Satchit and Valenzuela, Marcela and Westheide, Christian, Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk (August 2022). SAFE Working Paper No. 234, Available at SSRN: https://ssrn.com/abstract=3276548 or http://dx.doi.org/10.2139/ssrn.3276548

Alejandro Bernales

Universidad de Chile ( email )

Diagonal Paraguay 257
Santiago
Chile

HOME PAGE: http://www.alejandrobernales.com

Nicolás Garrido

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

Satchit Sagade (Contact Author)

Nasdaq, Inc. ( email )

Tullvaktsvägen 15
Stockholm, Stockholm 105 78
Sweden
+4684057967 (Phone)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 176 72222 049 (Phone)

Marcela Valenzuela

Pontificia Universidad Católica de Chile ( email )

Vicuña Mackenna 4860
Santiago, R. Metropolitana 7520421
Chile

Christian Westheide

University of Vienna - Department of Finance ( email )

Bruennerstrasse 72
Vienna, 1210
Austria

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