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Does the Prohibition of Trade-Through Hurt Liquidity Demanders?

Author

Listed:
  • Ningyuan Chen

    (Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3E6, Canada)

  • Pin Gao

    (School of Data Science, The Chinese University of Hong Kong, Shenzhen 518172, China; Shenzhen Institute of Artificial Intelligence and Robotics for Society, Shenzhen 518172, China)

  • Steven Kou

    (Department of Finance, Questrom School of Business, Boston University, Boston, Massachusetts 02215)

Abstract

The order protect rule (OPR) in the United States generally prohibits any trade-through, that is, a market order that is not executed at the best possible price among fast (electronic and automated) trading venues. By deriving upper and lower bounds for the difference in the execution costs in a dynamic model, we find that, although trade-through allows for flexible trading strategies and may benefit the liquidity demander, the benefit is insignificant in most cases, especially for small trades and stocks with fast resilience. Therefore, considering other benefits of the OPR studied in the literature, this study supports the regulation and suggests that the current separate regulations for fast and slow venues may be extended to differentiate stocks with fast and slow resilience speeds.

Suggested Citation

  • Ningyuan Chen & Pin Gao & Steven Kou, 2023. "Does the Prohibition of Trade-Through Hurt Liquidity Demanders?," Operations Research, INFORMS, vol. 71(5), pages 1458-1471, September.
    • Handle: RePEc:inm:oropre:v:71:y:2023:i:5:p:1458-1471
    DOI: 10.1287/opre.2023.2454
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