Siphoned Apart: A Portfolio Perspective on Order Flow Segmentation

70 Pages Posted: 4 Aug 2022 Last revised: 28 Mar 2023

Date Written: March 28, 2023


We study liquidity provision in fragmented markets. Market makers intermediate heterogeneous order flows, trading off expected spread revenue against inventory costs. Applying our model to payment for order flow (PFOF), we demonstrate that portfolio-based considerations of inventory management incentivize market makers to segment retail orders by siphoning them off-exchange. Banning order flow segmentation unambiguously hurts welfare, can make trading more costly for all investors, and can resolve a prisoner’s dilemma affecting market makers. These results differentiate our inventory-based model from the existing information-based theories of PFOF.

Keywords: order flow segmentation, payment for order flow, inventory management, market maker, retail investor

JEL Classification: D47, G11, G18

Suggested Citation

Baldauf, Markus and Mollner, Joshua and Yueshen, Bart Zhou, Siphoned Apart: A Portfolio Perspective on Order Flow Segmentation (March 28, 2023). Available at SSRN: or

Markus Baldauf

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2

Joshua Mollner (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States

Bart Zhou Yueshen

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex

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