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Trading rules, competition for order flow and market fragmentation

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  • Kwan, Amy
  • Masulis, Ronald
  • McInish, Thomas H.

Abstract

We investigate competition between traditional stock exchanges and new dark trading venues using an important difference in regulatory treatment. Securities and Exchange Commission required minimum pricing increments constrain some stock spreads, causing large limit order queues. Dark pools allow some traders to bypass existing limit order queues with minimal price improvement. Using a regression discontinuity design, we find that spread constraints significantly weaken exchanges׳ competitiveness. As more orders migrate to dark pools, the probability of subsequent order execution there increases, raising liquidity. The ability to circumvent time priority of displayed limit orders is one cause of the rapid rise in US equity market fragmentation.

Suggested Citation

  • Kwan, Amy & Masulis, Ronald & McInish, Thomas H., 2015. "Trading rules, competition for order flow and market fragmentation," Journal of Financial Economics, Elsevier, vol. 115(2), pages 330-348.
    • Handle: RePEc:eee:jfinec:v:115:y:2015:i:2:p:330-348
    DOI: 10.1016/j.jfineco.2014.09.010
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    References listed on IDEAS

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    More about this item

    Keywords

    Market fragmentation; Regression discontinuity; Dark pools; Trade reporting facility;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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