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Trading in Fragmented Markets

Published online by Cambridge University Press:  05 June 2020

Markus Baldauf Open the ORCID record for Markus Baldauf [Opens in a new window]  and
Joshua Mollner
Markus Baldauf*
Affiliation:
Baldauf, [email protected], University of British Columbia Sauder School of Business
Joshua Mollner
Affiliation:
Mollner, [email protected], Northwestern University Kellogg School of Management
*
Baldauf (corresponding author), [email protected]
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Abstract

We study fragmentation of equity trading using a model of imperfect competition among exchanges. In the model, increased competition drives down trading fees. However, additional arbitrage opportunities arise in fragmented markets, intensifying adverse selection. Due to these opposing forces, the effects of fragmentation are context dependent. To empirically investigate the ambiguity in a single context, we estimate key parameters of the model with order-level data for an Australian security. According to the estimates, the benefits of increased competition are outweighed by the costs of multi-venue arbitrage. Compared with the prevailing duopoly, we predict the counterfactual monopoly spread to be 23% lower.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 1 , February 2021 , pp. 93 - 121
Copyright
© Michael G. Foster School of Business, University of Washington 2019

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Footnotes

We are indebted to our advisors Timothy Bresnahan, Gabriel Carroll, Jonathan Levin, Paul Milgrom, and Monika Piazzesi. We also thank James Angel, Lanier Benkard, Philip Bond, Jean-Edouard Colliard (discussant), Carole Comerton-Forde, Alan Crawford, Darrell Duffie, Liran Einav, Thierry Foucault, Lorenzo Garlappi, Lawrence Glosten (discussant), Duncan Gilchrist, Terrence Hendershott, Christiaan Hogendorn, Yingxiang Li, Katya Malinova (discussant), Albert Menkveld, Peter Reiss, Alvin Roth, Georgios Skoulakis, Laura Tuttle, Brian Weller, Mao Ye, and seminar participants, as well as various industry experts, for valuable comments. This work used the Extreme Science and Engineering Discovery Environment (XSEDE), which is supported by National Science Foundation grant OCI-1053575. Baldauf acknowledges financial support from the Stanford Institute for Economic Policy Research Kohlhagen Fellowship Fund and the Social Sciences and Humanities Research Council (SSHRC) grant 430-2018-00100. Mollner acknowledges financial support from the Stanford Institute for Economic Policy Research Kapnick Fellowship Program.

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