Competition for Order Flow and Smart Order Routing Systems

63 Pages Posted: 14 Jun 2006

See all articles by Thierry Foucault

Thierry Foucault

HEC Paris - Finance Department

Albert J. Menkveld

VU Amsterdam; Tinbergen Institute

Multiple version iconThere are 2 versions of this paper

Date Written: March 2006

Abstract

We study changes in liquidity following the introduction of a new electronic limit order market when, prior to its introduction, trading is centralized in a single limit order market. We also study how automation of routing decisions and trading fees affect the relative liquidity of rival markets. The theoretical analysis yields three main predictions: (i) consolidated depth is larger in the multiple limit order markets environment, (ii) consolidated bid-ask spread is smaller in the multiple limit order markets environment and (iii) the liquidity of the entrant market relative to that of the incumbent market increases with the level of automation for routing decisions (the proportion of 'smart routers'). We test these predictions by studying the rivalry between the London Stock Exchange (entrant) and Euronext (incumbent) in the Dutch stock market. The main predictions of the model are supported.

Keywords: Market fragmentation, centralized limit order book, smart routers, trading fees, trade-throughs

JEL Classification: G10, G18, G24, L13

Suggested Citation

Foucault, Thierry and Menkveld, Albert J., Competition for Order Flow and Smart Order Routing Systems (March 2006). CEPR Discussion Paper No. 5523. Available at SSRN: https://ssrn.com/abstract=908847

Thierry Foucault (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
(33)139679569 (Phone)
(33)139677085 (Fax)

HOME PAGE: http://thierryfoucault.com/

Albert J. Menkveld

VU Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands
+31 20 5986130 (Phone)
+31 20 5986020 (Fax)

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
20
Abstract Views
893
PlumX Metrics