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The paradoxical effects of market fragmentation on adverse selection risk and market efficiency

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  • Gbenga Ibikunle
  • Davide Mare
  • Yuxin Sun

Abstract

Unlike the US’s Regulation National Market System (RNMS), the EU’s Markets in Financial Instruments Directive (MiFID) does not impose a formal exchange trading linkage or guarantee a best execution price. This raises concerns about consolidated market quality in increasingly fragmented European markets. We investigate the impact of visible trading fragmentation on the quality of the London equity market and find a non-linear relationship between fragmentation and adverse selection risk. At moderate levels of fragmentation, order flow competition reduces adverse selection risk and enhances market efficiency by reducing arbitrage opportunities. Contrarily, high levels of fragmentation heighten adverse selection issues.

Suggested Citation

  • Gbenga Ibikunle & Davide Mare & Yuxin Sun, 2020. "The paradoxical effects of market fragmentation on adverse selection risk and market efficiency," The European Journal of Finance, Taylor & Francis Journals, vol. 26(14), pages 1439-1461, September.
    • Handle: RePEc:taf:eurjfi:v:26:y:2020:i:14:p:1439-1461
    DOI: 10.1080/1351847X.2020.1745861
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