Competition for Retail Order Flow and Market Quality

61 Pages Posted: 3 Apr 2022 Last revised: 7 Oct 2022

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


Approximately 27% of trading volume is routed from retail brokerages to seven market-making firms (“internalizers”). We estimate that two of these firms, Citadel and Virtu, handle 70% of this volume, or $70 trillion from 2017-2021. Our theoretical model predicts that spreads are wider in a non-competitive market for retail order flow, as internalizers have less incentive to use their profits to improve on-exchange liquidity. Using the SEC Tick Size Pilot, which restricted internalization in some stocks as a natural experiment, we provide evidence that internalization negatively affects market liquidity, and that this effect is especially strong for stocks with concentrated internalization volume, as measured by our internalizer Herfindahl-Hirschman Index. Our results suggest that promoting more 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: or

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)


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