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Liquidity cycles and make/take fees in electronic markets

Author

Listed:
  • Foucault, Thierry
  • Kadan, Ohad
  • Kandel, Eugene

Abstract

In this paper, the authors develop a dynamic model of trading with two specialized sides: traders posting quotes (“market makers”) and traders hitting quotes (“market takers”). Traders monitor the market to seize profit opportunities, generating high frequency make/take liquidity cycles. Monitoring decisions by market-makers and market-takers are self-reinforcing, generating multiple equilibria with differing liquidity levels and duration clustering. The trading rate is typically maximized when makers and takers are charged different fees or even paid rebates, as observed in reality. The model yields several empirical implications regarding the determinants of make/take fees, the trading rate, the bid-ask spread, and the effect of algorithmic trading on these variables. Finally, algorithmic trading can improve welfare because it increases the rate at which gains from trade are realized.

Suggested Citation

  • Foucault, Thierry & Kadan, Ohad & Kandel, Eugene, 2009. "Liquidity cycles and make/take fees in electronic markets," HEC Research Papers Series 920, HEC Paris.
    • Handle: RePEc:ebg:heccah:0920
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    More about this item

    Keywords

    liquidity; monitoring; make/take fees; duration clustering; algorithmic trading; two-sided markets;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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    This paper has been announced in the following NEP Reports:

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