Would Order-by-Order Auctions Be Competitive?

79 Pages Posted: 23 Dec 2022 Last revised: 9 Mar 2023

See all articles by Thomas Ernst

Thomas Ernst

University of Maryland - Robert H Smith School of Business

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business

Jian Sun

Lee Kong Chian School of Business, Singapore Management University

Date Written: December 13, 2022

Abstract

Retail trading flow is segregated from non-retail flow in U.S. equities, consistent with market segmentation. We model theoretically two methods of executing segregated retail trades: a) broker's routing, whereby brokers evaluate and allocate orders based on each market maker's aggregate performance, and b) order-by-order auctions, where market makers bid on each individual order, a market structure recently proposed by the SEC. We find that order-by-order auctions improve allocative efficiency among market makers, but a winner's curse problem in the auction can reduce retail investor welfare, particularly at times of limited liquidity. Introducing more market participants who compete for retail orders can harm both total efficiency and investor welfare if these new market participants have superior information compared to incumbent wholesalers. Empirical analysis of Retail Liquidity Programs (RLP) currently offered by exchanges shows that these programs behave similar to order-by-order auctions in our model.

Keywords: Order By Order Competition, Auctions, Retail Trading, Routing, Brokers, PFOF

JEL Classification: G14, G18, G20

Suggested Citation

Ernst, Thomas and Spatt, Chester S. and Sun, Jian, Would Order-by-Order Auctions Be Competitive? (December 13, 2022). Available at SSRN: https://ssrn.com/abstract=4300505 or http://dx.doi.org/10.2139/ssrn.4300505

Thomas Ernst (Contact Author)

University of Maryland - Robert H Smith School of Business ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-8834 (Phone)
412-268-6689 (Fax)

Jian Sun

Lee Kong Chian School of Business, Singapore Management University ( email )

Li Ka Shing Library
70 Stamford Road
Singapore 178901, 178899
Singapore

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