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The impact of fragmentation, exchange fees and liquidity provision on market quality

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  • Aitken, Michael
  • Chen, Haoming
  • Foley, Sean

Abstract

We analyse the impact of two major financial frictions on market quality in a high-frequency environment: market fragmentation and exchange fees. We find fragmentation significantly improves market quality, with benefits increasing with greater fragmentation. Fragmentation significantly reduces spreads for stocks that are least constrained by the minimum tick size, whilst constrained stocks experience significant increases in depth. Using high-frequency data we document cross-market liquidity dynamics, demonstrating that entrant markets need to trade (not only quote) in order to improve liquidity, and that endogenous liquidity suppliers increase their usage of the alternate market when queues on the incumbent exchange are long and quoted spreads are constrained by the minimum tick size, consistent with queue-jumping order duplication.

Suggested Citation

  • Aitken, Michael & Chen, Haoming & Foley, Sean, 2017. "The impact of fragmentation, exchange fees and liquidity provision on market quality," Journal of Empirical Finance, Elsevier, vol. 41(C), pages 140-160.
  • Handle: RePEc:eee:empfin:v:41:y:2017:i:c:p:140-160
    DOI: 10.1016/j.jempfin.2016.10.002
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Angelo Aspris & Sean Foley & Peter O'Neill, 2020. "Benchmarks in the spotlight: The impact on exchange traded markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(11), pages 1691-1710, November.
    2. Indriawan, Ivan, 2020. "Market quality around macroeconomic news announcements: Evidence from the Australian stock market," Pacific-Basin Finance Journal, Elsevier, vol. 61(C).
    3. Markus Baldauf & Joshua Mollner, 2020. "High‐Frequency Trading and Market Performance," Journal of Finance, American Finance Association, vol. 75(3), pages 1495-1526, June.
    4. Aghanya, Daniel & Agarwal, Vineet & Poshakwale, Sunil, 2020. "Market in Financial Instruments Directive (MiFID), stock price informativeness and liquidity," Journal of Banking & Finance, Elsevier, vol. 113(C).
    5. Foley, Sean & Kwan, Amy & Low, Siyuan Adrian & Svec, Jiri, 2018. "The rise before the close: Underwriter trading around SEOs," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 221-235.
    6. Zhou, Hao & Kalev, Petko S., 2019. "Algorithmic and high frequency trading in Asia-Pacific, now and the future," Pacific-Basin Finance Journal, Elsevier, vol. 53(C), pages 186-207.
    7. Zhou, Hao & Kalev, Petko S. & Frino, Alex, 2020. "Algorithmic trading in turbulent markets," Pacific-Basin Finance Journal, Elsevier, vol. 62(C).
    8. Daniel Chen & Darrell Duffie, 2020. "Market Fragmentation," NBER Working Papers 26828, National Bureau of Economic Research, Inc.
    9. Pham, Manh Cuong & Anderson, Heather Margot & Duong, Huu Nhan & Lajbcygier, Paul, 2020. "The effects of trade size and market depth on immediate price impact in a limit order book market," Journal of Economic Dynamics and Control, Elsevier, vol. 120(C).

    More about this item

    Keywords

    Competition; Fragmentation; Queue jumping; Trading fees;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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