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Adverse selection, market access and inter-market competition

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  • Hoffmann, Peter

Abstract

We study the role of informed trading in a fragmented financial market under the absence of inter-market price priority. Due to frictions in traders’ market access, liquidity providers on alternative trading platforms may be exposed to an increased adverse selection risk. As a consequence, the main market dominates (offers better quotes) frequently albeit charging higher transaction fees. The empirical analysis of a dataset of trading in French and German stocks suggests that trades on Chi-X, a lowcost trading platform, carry significantly more private information than those executed in the Primary Markets. Consistent with our theory, we find a negative relationship between the competitiveness of Chi-X’s quotes and this excess adverse selection risk faced by liquidity providers in the cross-section. Our results have some implications for the design of best-execution policies. JEL Classification: G10, G14, G24

Suggested Citation

  • Hoffmann, Peter, 2013. "Adverse selection, market access and inter-market competition," Working Paper Series 1519, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20131519
    Note: 1137913
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1519.pdf
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    1. repec:bla:jfinan:v:58:y:2003:i:6:p:2637-2666 is not listed on IDEAS
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    Keywords

    adverse selection; Inter-market competition; MiFID; Transaction fees;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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