A General Analysis of Brokers' Trading, with Applications to Order Flow Internalization and Off-Exchange Block Sales

32 Pages Posted: 1 Jun 1998

See all articles by Sugato Chakravarty

Sugato Chakravarty

Purdue University

Asani Sarkar

Federal Reserve Bank of New York

Date Written: April 1998

Abstract

We study a variety of issues related to brokers' trading. In our model, multiple informed traders and noise traders trade through multiple brokers. Brokers may trade with their customers in the same transaction (simultaneous dual trading) or trade after their customers in a separate transaction (consecutive dual trading). With a fixed number of traders, and relative to consecutive dual trading, informed and noise traders are worse off, brokers are better off, and market depth is lower in the simultaneous dual trading market. When we endogenize the number of brokers, informed and noise traders choose one (all) broker(s) in the simultaneous (consecutive) dual trading market. If the entry cost is low, more informed traders enter the simultaneous dual trading market and market depth may be higher relative to consecutive dual trading. If the entry cost is high, consecutive dual trading is better. We study order flow internalization by broker-dealers, and show that, in the free entry equilibrium, internalization hurts retail customers and market quality; and that it is likely to be more prevalent in thin markets with few informed traders. Finally, we examine off-exchange block sales and find that, compared to exchange transactions, they are more liquid but less informative.

JEL Classification: G10, G14, G18

Suggested Citation

Chakravarty, Sugato and Sarkar, Asani, A General Analysis of Brokers' Trading, with Applications to Order Flow Internalization and Off-Exchange Block Sales (April 1998). Available at SSRN: https://ssrn.com/abstract=93689 or http://dx.doi.org/10.2139/ssrn.93689

Sugato Chakravarty

Purdue University ( email )

Consumer Sciences
1262 Matthews Hall Rm 214F
West Lafayette, IN 47906
United States
765-494-6427 (Phone)
765-494-0869 (Fax)

HOME PAGE: http://web.ics.purdue.edu/~sugato

Asani Sarkar (Contact Author)

Federal Reserve Bank of New York ( email )

Research Department
33 Liberty Street
New York, NY 10045
United States
212-720-8943 (Phone)
212-720-1582 (Fax)

HOME PAGE: http://www.newyorkfed.org/research/economists/sarkar/pub.html

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