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Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk

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  • Bernales, Alejandro
  • Garrido, Nicolás
  • Sagade, Satchit
  • Valenzuela, Marcela
  • Westheide, Christian

Abstract

By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.

Suggested Citation

  • Bernales, Alejandro & Garrido, Nicolás & Sagade, Satchit & Valenzuela, Marcela & Westheide, Christian, 2020. "Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk," SAFE Working Paper Series 234, Leibniz Institute for Financial Research SAFE, revised 2020.
    • Handle: RePEc:zbw:safewp:234
    DOI: 10.2139/ssrn.3276548
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    Cited by:

    1. Bernales, Alejandro & Ladley, Daniel & Litos, Evangelos & Valenzuela, Marcela, 2021. "Dark trading and alternative execution priority rules," LSE Research Online Documents on Economics 118866, London School of Economics and Political Science, LSE Library.
    2. Daniel Chen & Darrell Duffie, 2021. "Market Fragmentation," American Economic Review, American Economic Association, vol. 111(7), pages 2247-2274, July.

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    More about this item

    Keywords

    Fragmentation; Competition; Liquidity; Price Efficiency;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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