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Connecting Disconnected Financial Markets?

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  • Milena Wittwer

Abstract

In most financial markets, securities are traded in isolation. Such a disconnected market design can be inefficient if agents trade more than one security. I assess welfare effects of connecting markets by allowing orders for one security to depend on prices of other securities. I show that everyone trades identical amounts under both market structures if and only if the clearing prices are perfectly correlated or all are price-takers. Prices in disconnected markets might allow strategic traders to extract higher rents from nonstrategic traders. In expectation, connected markets generate higher welfare, but all markets become efficient as they grow large.

Suggested Citation

  • Milena Wittwer, 2021. "Connecting Disconnected Financial Markets?," American Economic Journal: Microeconomics, American Economic Association, vol. 13(1), pages 252-282, February.
    • Handle: RePEc:aea:aejmic:v:13:y:2021:i:1:p:252-82
    DOI: 10.1257/mic.20180314
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    References listed on IDEAS

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    6. Eric Budish & Robin S. Lee & John J. Shim, 2019. "A Theory of Stock Exchange Competition and Innovation: Will the Market Fix the Market?," NBER Working Papers 25855, National Bureau of Economic Research, Inc.
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    8. Jean-Pierre Zigrand, 2005. "Rational Asset Pricing Implications from Realistic Trading Frictions," The Journal of Business, University of Chicago Press, vol. 78(3), pages 871-892, May.
    9. Ali Hortaçsu & David McAdams, 2010. "Mechanism Choice and Strategic Bidding in Divisible Good Auctions: An Empirical Analysis of the Turkish Treasury Auction Market," Journal of Political Economy, University of Chicago Press, vol. 118(5), pages 833-865.
    10. Du, Songzi & Zhu, Haoxiang, 2017. "Bilateral trading in divisible double auctions," Journal of Economic Theory, Elsevier, vol. 167(C), pages 285-311.
    11. Kastl, Jakub, 2012. "On the properties of equilibria in private value divisible good auctions with constrained bidding," Journal of Mathematical Economics, Elsevier, vol. 48(6), pages 339-352.
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    Cited by:

    1. Suchismita Mishra & Le Zhao, 2021. "Order Routing Decisions for a Fragmented Market: A Review," JRFM, MDPI, vol. 14(11), pages 1-32, November.
    2. Eric Budish & Peter Cramton & Albert S. Kyle & Jeongmin Lee & David Malec, 2022. "Flow Trading," ECONtribute Discussion Papers Series 146, University of Bonn and University of Cologne, Germany.
    3. Jason Allen & Jakub Kastl & Milena Wittwer, 2020. "Maturity Composition and the Demand for Government Debt," Staff Working Papers 20-29, Bank of Canada.
    4. Marzena Rostek & Ji Hee Yoon, 2021. "Exchange Design and Efficiency," Econometrica, Econometric Society, vol. 89(6), pages 2887-2928, November.
    5. Jason Allen & Milena Wittwer, 2023. "Intermediary Market Power and Capital Constraints," Staff Working Papers 23-51, Bank of Canada.

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    More about this item

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • H82 - Public Economics - - Miscellaneous Issues - - - Governmental Property

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