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Competition for Order Flow and Smart Order Routing Systems

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  • THIERRY FOUCAULT
  • ALBERT J. MENKVELD

Abstract

We study the rivalry between Euronext and the London Stock Exchange (LSE) in the Dutch stock market to test hypotheses about the effect of market fragmentation. As predicted by our theory, the consolidated limit order book is deeper after entry of the LSE. Moreover, cross-sectionally, we find that a higher trade-through rate in the entrant market coincides with less liquidity supply in this market. These findings imply that (i) fragmentation of order flow can enhance liquidity supply and (ii) protecting limit orders against trade-throughs is important. Copyright 2008 by The American Finance Association.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6261.2008.01312.x
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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 63 (2008)
Issue (Month): 1 (02)
Pages: 119-158

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Handle: RePEc:bla:jfinan:v:63:y:2008:i:1:p:119-158

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  1. Terrence Hendershott & Charles M. Jones, 2005. "Island Goes Dark: Transparency, Fragmentation, and Regulation," Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 743-793.
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  3. Battalio, Robert H, 1997. " Third Market Broker-Dealers: Cost Competitors or Cream Skimmers?," Journal of Finance, American Finance Association, vol. 52(1), pages 341-52, March.
  4. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
  5. Hendershott, Terrence & Jones, Charles M., 2005. "Trade-through prohibitions and market quality," Journal of Financial Markets, Elsevier, vol. 8(1), pages 1-23, February.
  6. Mendelson, Haim, 1987. "Consolidation, Fragmentation, and Market Performance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 189-207, June.
  7. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 103-50.
  8. Bessembinder, Hendrik, 2003. "Quote-based competition and trade execution costs in NYSE-listed stocks," Journal of Financial Economics, Elsevier, vol. 70(3), pages 385-422, December.
  9. Boehmer, Beatrice & Boehmer, Ekkehart, 2003. "Trading your neighbor's ETFs: Competition or fragmentation?," Journal of Banking & Finance, Elsevier, vol. 27(9), pages 1667-1703, September.
  10. Dybvig, Philip H. & Spatt, Chester S., 1983. "Adoption externalities as public goods," Journal of Public Economics, Elsevier, vol. 20(2), pages 231-247, March.
  11. Pagano, Marco, 1989. "Trading Volume and Asset Liquidity," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 255-74, May.
  12. Chowdhry, Bhagwan & Nanda, Vikram, 1991. "Multimarket Trading and Market Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 4(3), pages 483-511.
  13. Fink, Jason & Fink, Kristin E. & Weston, James P., 2006. "Competition on the Nasdaq and the growth of electronic communication networks," Journal of Banking & Finance, Elsevier, vol. 30(9), pages 2537-2559, September.
  14. Michael J. Barclay & Terrence Hendershott & D. Timothy McCormick, 2003. "Competition among Trading Venues: Information and Trading on Electronic Communications Networks," Journal of Finance, American Finance Association, vol. 58(6), pages 2637-2666, December.
  15. Harris, L., 1990. "Liquidity , Trading Rules and Electronic Trading Systems ," Papers 91-8, Southern California - School of Business Administration.
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