What is the Value of Retail Order Flow?

55 Pages Posted: 3 Sep 2024

See all articles by Peter Hoffmann

Peter Hoffmann

European Central Bank (ECB)

Stephan Jank

Deutsche Bundesbank

Multiple version iconThere are 2 versions of this paper

Date Written: July 01, 2024

Abstract

This paper uses regulatory data to assess the value of retail order flow in the German equity market. To this end, we examine the performance of specialized retail market makers (RMMs) that internalize a large share of retail activity via affiliated trading venues. We show that retail market making is extremely profitable, with an average (gross) Sharpe ratio of 17.85, which is more than twice as large as that earned by proprietary trading firms (PTFs) active in public limit order markets. A simple calculation suggest that RMMs would be willing to give up around 60% of their revenues, or 1.76 bps of their trading volume, for access to retail order flow. The profitability of retail market making is rooted in reduced exposure to adverse selection and inventory risk.

Keywords: Equity markets, retail trading, market making, internalization, payment for order flow

JEL Classification: G10, G12

Suggested Citation

Hoffmann, Peter and Jank, Stephan, What is the Value of Retail Order Flow? (July 01, 2024). Deutsche Bundesbank Discussion Paper No. 33/2024, Available at SSRN: https://ssrn.com/abstract=4945878 or http://dx.doi.org/10.2139/ssrn.4945878

Peter Hoffmann (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Stephan Jank

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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