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Liquidity cycles and make/take fees in electronic markets

  • Foucault, Thierry
  • Kadan, Ohad
  • Kandel, Eugene

We develop a dynamic model of a market with two specialized sides: traders posting quotes ("market makers") and traders hitting quotes ("market takers"). Traders monitor the market to seize profit opportunities, generating high frequency liquidity cycles. Monitoring decisions by market-makers and market-takers are self-reinforcing, generating multiple equilibria with differing liquidity levels and duration clustering. The trading rate is typically maximized when makers and takers are charged different fees or even paid rebates. The model yields several empirical implications regarding the determinants of make/take fees, the trading rate, the bid-ask spread, and the effects of algorithmic trading on liquidity and welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7551.

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Date of creation: Nov 2009
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Handle: RePEc:cpr:ceprdp:7551
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  1. James Dow, 2004. "Is Liquidity Self-Fulfilling?," The Journal of Business, University of Chicago Press, vol. 77(4), pages 895-908, October.
  2. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
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  4. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2005. "Limit Order Book as a Market for Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1171-1217.
  5. Pagano, Marco, 1986. "Trading Volume and Asset Liquidity," CEPR Discussion Papers 142, C.E.P.R. Discussion Papers.
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  16. Hasbrouck, Joel & Saar, Gideon, 2009. "Technology and liquidity provision: The blurring of traditional definitions," Journal of Financial Markets, Elsevier, vol. 12(2), pages 143-172, May.
  17. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
  18. Large, Jeremy, 2007. "Measuring the resiliency of an electronic limit order book," Journal of Financial Markets, Elsevier, vol. 10(1), pages 1-25, February.
  19. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  20. Sugato Chakravarty & Robert A. Wood & Robert A. Van Ness, 2004. "Decimals And Liquidity: A Study Of The Nyse," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 27(1), pages 75-94.
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  23. repec:dgr:kubcen:200280 is not listed on IDEAS
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