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Fragmentation and Strategic Market-Making

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  • Laurence Daures Lescourret
  • Sophie Moinas

Abstract

Information technology, infrastructure enhancement, and arbitrage strategies all contributeto link trading venues in fragmented markets. Our paper highlights a new cross-market linking channel: the interdependence of liquidity providers' inventory costs. We use a two-venue duopoly model involving strategic risk-averse market-makers. Costs to provide immediacy depend on market-makers' inventory aggregated across venues, implying that absorbing a shock in one venue simultaneously changes marginal costs in all other venues. Moreover, market-makers strategically choose which shock(s) to absorb. These two forces may lead to competitive prices and enhanced liquidity. Using Euronext proprietary data, we uncover evidence for these crossmarket inventory cost linkages.

Suggested Citation

  • Laurence Daures Lescourret & Sophie Moinas, 2018. "Fragmentation and Strategic Market-Making," EconPol Working Paper 15, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
  • Handle: RePEc:ces:econwp:_15
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    File URL: https://www.ifo.de/DocDL/EconPol_Working_Paper_15_2018.pdf
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    References listed on IDEAS

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    1. Gagnon, Louis & Andrew Karolyi, G., 2010. "Multi-market trading and arbitrage," Journal of Financial Economics, Elsevier, vol. 97(1), pages 53-80, July.
    2. Stephen R. Foerster & G. Andrew Karolyi, 1999. "The Effects of Market Segmentation and Investor Recognition on Asset Prices: Evidence from Foreign Stocks Listing in the United States," Journal of Finance, American Finance Association, vol. 54(3), pages 981-1013, June.
    3. Xiangkang Yin, 2005. "A Comparison of Centralized and Fragmented Markets with Costly Search," Journal of Finance, American Finance Association, vol. 60(3), pages 1567-1590, June.
    4. Biais, Bruno & Foucault, Thierry & Salanie, Francois, 1998. "Floors, dealer markets and limit order markets," Journal of Financial Markets, Elsevier, vol. 1(3-4), pages 253-284, September.
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    Cited by:

    1. Foucault, Thierry & Moinas, Sophie, 2018. "Is Trading Fast Dangerous?," TSE Working Papers 18-881, Toulouse School of Economics (TSE).
    2. Bernales, Alejandro & Garrido, Nicolás & Sagade, Satchit & Valenzuela, Marcela & Westheide, Christian, 2020. "Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk," SAFE Working Paper Series 234, Leibniz Institute for Financial Research SAFE.
    3. Tomy Lee, 2019. "Latency in Fragmented Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 128-153, July.

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