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Splitting Orders

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Author Info
Bernhardt, Dan
Hughson, Eric

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Abstract

A standard presumption of market microstructure models is that competition between risk-neutral market makers inevitably leads to price schedules that leave market makers zero expected profits conditional on the order flow. This article documents an important lack of robustness of this zero-profit result. In particular, we show that if traders can split orders between market makers, then market makers set less-competitive price schedules that earn them strictly positive profits and hence raise trading costs. Thus, this article can explain why somebody might willingly make a market for a stock when there are fixed costs to doing so. The analysis extends to a limit order book, which by its nature is split against incoming market orders: equilibrium limit order schedules necessarily yield those agents positive expected profits. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 10 (1997)
Issue (Month): 1 ()
Pages: 69-101
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Handle: RePEc:oup:rfinst:v:10:y:1997:i:1:p:69-101

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  1. A.J. Menkveld, 2001. "Splitting orders in fragmented markets - evidence from cross-listed stocks," Econometric Institute Report 227, Erasmus University Rotterdam, Econometric Institute. [Downloadable!]
    Other versions:
  2. Alexis Derviz, 2003. "FOREX Microstructure, Invisible Price Determinants, and the Central Bank's Understanding of Exchange Rate Formation," Working Papers 2003/06, Czech National Bank, Research Department. [Downloadable!]
  3. Alexis Derviz, 2003. "Components of the Czech Koruna Risk Premium in a Multiple-Dealer FX Market," Working Papers 2003/04, Czech National Bank, Research Department. [Downloadable!]
  4. Menkveld, Albert J., 2006. "Splitting orders in overlapping markets: a study of cross-listed stocks," Serie Research Memoranda 0003, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics. [Downloadable!]
    Other versions:
  5. Bert Menkveld, 2001. "Splitting Orders in Fragmented Markets," Tinbergen Institute Discussion Papers 01-059/2, Tinbergen Institute. [Downloadable!]
  6. Salomonsson, Marcus, 2009. "Introducing a spread into the Kyle model," Working Paper Series in Economics and Finance 713, Stockholm School of Economics. [Downloadable!]
  7. Buti, Sabrina, 2007. "A Challenger to the Limit Order Book: The NYSE Specialist," SIFR Research Report Series 55, Institute for Financial Research. [Downloadable!]
  8. Biais, Bruno & Bisière, Christophe & Spatt, Chester, 2003. "Imperfect Competition in Financial Markets: ISLAND versus NASDAQ," IDEI Working Papers 220, Institut d'Économie Industrielle (IDEI), Toulouse, revised Dec 2006. [Downloadable!]
  9. Bruno Biais & Christophe Bisiere & Chester Spatt, 2002. "Imperfect Competition in Financial Markets: ISLAND vs. NASDAQ," GSIA Working Papers 2003-E41, Carnegie Mellon University, Tepper School of Business. [Downloadable!]
  10. Menkhoff, Lukas & Schmeling, Maik, 2009. "Trader see, trader do: How do (small) FX traders react to large counterparties' trades?," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-415, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
  11. Andy Snell & Ian Tonks, 2004. "Trading Costs of Institutional Investors in Auction and Dealer Markets," ESE Discussion Papers 89, Edinburgh School of Economics, University of Edinburgh. [Downloadable!]
  12. Menkhoff, Lukas & Schmeling, Maik, 2007. "Whose trades convey information? Evidence from a cross-section of traders," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-357, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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