Competition for Retail Order Flow and Market Quality

60 Pages Posted: 3 Apr 2022 Last revised: 9 Jan 2024

See all articles by Edwin Hu

Edwin Hu

New York University School of Law

Dermot Murphy

University of Illinois at Chicago

Date Written: June 8, 2022

Abstract

Two market-makers internally executed 70% of retail orders between 2017-2021 ($70 trillion; 19% of total volume). The concentration of retail trading away from exchanges can provide economies of scale, but may reduce competition on exchanges. We find that internalization is associated with higher spreads and worse price improvement, especially for stocks with high internalizer Herfindahl-Hirschman Index (HHI) levels. Experimental findings from the Tick Size Pilot internalization restrictions and internalizer outages during the "meme stock" frenzy support a causal interpretation. We argue that promoting competitive markets for retail order flow could save investors billions of dollars in transaction costs.

Keywords: payment for order flow, retail trading, market quality, internalization, wholesalers, competition

JEL Classification: G12, G18, D43

Suggested Citation

Hu, Edwin and Murphy, Dermot, Competition for Retail Order Flow and Market Quality (June 8, 2022). Available at SSRN: https://ssrn.com/abstract=4070056 or http://dx.doi.org/10.2139/ssrn.4070056

Edwin Hu

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States

Dermot Murphy (Contact Author)

University of Illinois at Chicago ( email )

2114 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States
312-355-4372 (Phone)

HOME PAGE: http://sites.google.com/site/murphyderm

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