Would Order-By-Order Auctions Be Competitive?

Abstract

We model two methods of executing segregated retail orders: broker's routing, whereby brokers allocate orders using market maker's overall performance, and order-by-order auctions, where market makers bid on individual orders, a recent SEC proposal. Order-by-order auctions improve allocative efficiency, but face a winner's curse reducing retail investor welfare, particularly when liquidity is limited. Additional market participants competing for retail orders fail to improve total efficiency and investor welfare when entrants possess information superior to incumbent wholesalers. Our results remain robust when new entrants are less informed or the information structure differs. We also examine  the cross-subsidization of broker's routing.

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

JEL Classification: G14, G18, G20