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

49 Pages Posted: 5 Nov 2018 Last revised: 2 Jul 2020

See all articles by Alejandro Bernales

Alejandro Bernales

Universidad de Chile

Nicolás Garrido

University of Chile

Satchit Sagade

Goethe University Frankfurt - Department of Finance; Leibniz Institute for Financial Research SAFE

Marcela Valenzuela

Pontificia Universidad Católica de Chile

Christian Westheide

University of Vienna - Department of Finance; Leibniz Institute for Financial Research SAFE

Date Written: June 1, 2020

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

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 (June 1, 2020). 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)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany
+49 69 798 30085 (Phone)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 30085 (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

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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