Liquidity Provision Under Flat Commissions in a Maker-Taker World

Abstract

Many equity exchanges charge the two parties of a trade different fees, often subsidizing liquidity providers. We examine this asymmetric, or maker-taker, pricing in a model where some investors pay fees directly to the exchange, while others pay them only on average, through flat commissions. When the latter investor group is large, maker-taker pricing is distortionary: incentivized by the lower liquidity provider fees (or rebates), investors who pay fees directly become de facto market makers. The aggregate gains from trade decline, and there is redistribution from flat-fee investors to those who pay fees directly. Reducing the fee asymmetry or lowering the share of investors who face flat commissions mitigate the distortions.

Keywords: Maker-taker fee, liquidity, limit order book

JEL Classification: G10, G12