Are Upstairs Markets Pareto Improving?

Abstract

We examine the price impact cost of block trades across three trading mechanisms: the upstairs market, a crossing network system, and the limit order book. While, unsurprisingly, both the upstairs market and crossing system provide lower price impact costs for block trades than downstairs, using unique exogenous measures of market access we find no evidence that competition from these external markets has an adverse affect. Thus, despite the threat that they drain liquidity and cream-skim to harm the main market, these alternative trading mechanisms appear from our evidence to be Pareto improving for all investor classes and market participants regardless of which market is the major focus.

Keywords: Fragmentation, upstairs trading, crossing networks, liquidity, cream skimming

JEL Classification: G14