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Middlemen in Limit Order Markets

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Author Info

  • Albert J. Menkveld

    (VU University Amsterdam)

  • Boyan Jovanovic

    (NYU Economics)

Abstract

We model high-frequency traders in electronic markets. We ask how the presence of such middlemen may affect welfare. We find that middlemen process public information faster than the average investor. As such, they can play a positive or a negative role. On the positive side, when they enter a market they can raise welfare by solving a pre-existing adverse selection problem. In that case their entry is accompanied by a rise in trade and a fall in bid-ask spreads, and they can raise welfare by up to 30% of the gap between its equilibrium level and its first-best level. On the negative side, they can create or exacerbate an adverse- selection problem, in which case spreads rise and trade declines. Our evidence on this score is mixed. On the one hand, middlemen’s participation lowers spreads but, on the other, it also lowers trade.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 955.

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Date of creation: 2010
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Handle: RePEc:red:sed010:955

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Cited by:
  1. Riccardo Cesari & Massimiliano Marzo & Paolo Zagaglia, 2012. "Effective Trade Execution," Papers 1206.5324, arXiv.org.
  2. Hasbrouck, Joel & Saar, Gideon, 2013. "Low-latency trading," Journal of Financial Markets, Elsevier, vol. 16(4), pages 646-679.
  3. Yacine Aït-Sahalia & Mehmet Saglam, 2013. "High Frequency Traders: Taking Advantage of Speed," NBER Working Papers 19531, National Bureau of Economic Research, Inc.
  4. Rodolfo E. Manuelli & Adrian Peralta-Alva, 2011. ""Frictions in financial and labor markets": a summary of the 35th Annual Economic Policy Conference," Review, Federal Reserve Bank of St. Louis, issue July, pages 273-292.

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