A Tale of One Exchange and Two Order Books: Effects of Fragmentation in the Absence of Competition

57 Pages Posted: 5 Nov 2018 Last revised: 5 Feb 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: October 2018

Abstract

Exchanges nowadays routinely operate multiple, almost identically structured limit order markets for the same security. We study the effects of such fragmentation on market performance using a dynamic model where agents trade strategically across two identically-organized limit order books. We show that fragmented markets, in equilibrium, offer higher welfare to intermediaries at the expense of investors with intrinsic trading motives, and lower liquidity than consolidated markets. Consistent with our theory, we document improvements in liquidity and lower profits for liquidity providers when Euronext, in 2009, consolidated its order flow for stocks traded across two country-specific and identically-organized order books into a single order book. Our results suggest that competition in market design, not fragmentation, drives previously documented improvements in market quality when new trading venues emerge; in the absence of such competition, market fragmentation is harmful.

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, A Tale of One Exchange and Two Order Books: Effects of Fragmentation in the Absence of Competition (October 2018). 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 )

República 701
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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