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Market quality and contagion in fragmented markets

Author

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  • Rahi, Rohit
  • Zigrand, Jean-Pierre

Abstract

Financial market liquidity has become increasingly fragmented across multiple trading platforms. We propose an intuitive welfare-based market quality metric that can properly aggregate local market conditions across both securities and trading venues. Our analysis rests on a general equilibrium model with segmented markets. Arbitrageurs reap profits by effectively providing intermediation services (i.e. “liquidity"). Our market quality measure is equal to the additional consumption enjoyed by investors as a result of this intermediation, and can be represented by means of a number of observable proxies. The model is especially well-suited to study the contagion-like effects of liquidity shocks.

Suggested Citation

  • Rahi, Rohit & Zigrand, Jean-Pierre, 2013. "Market quality and contagion in fragmented markets," LSE Research Online Documents on Economics 60971, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:60971
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    File URL: http://eprints.lse.ac.uk/60971/
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    References listed on IDEAS

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    1. Rohit Rahi & Jean-Pierre Zigrand, 2009. "Strategic Financial Innovation in Segmented Markets," The Review of Financial Studies, Society for Financial Studies, vol. 22(8), pages 2941-2971, August.
    2. Giovanni Cespa & Thierry Foucault, 2014. "Illiquidity Contagion and Liquidity Crashes," The Review of Financial Studies, Society for Financial Studies, vol. 27(6), pages 1615-1660.
    3. Peek, Joe & Rosengren, Eric S, 1997. "The International Transmission of Financial Shocks: The Case of Japan," American Economic Review, American Economic Association, vol. 87(4), pages 495-505, September.
    4. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," The Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
    5. Terrence Hendershott & Haim Mendelson, 2000. "Crossing Networks and Dealer Markets: Competition and Performance," Journal of Finance, American Finance Association, vol. 55(5), pages 2071-2115, October.
    6. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    7. Thierry Foucault & Albert J. Menkveld, 2008. "Competition for Order Flow and Smart Order Routing Systems," Journal of Finance, American Finance Association, vol. 63(1), pages 119-158, February.
    8. James Weston, 2002. "Electronic Communication Networks and Liquidity on the Nasdaq," Journal of Financial Services Research, Springer;Western Finance Association, vol. 22(1), pages 125-139, August.
    9. Karolyi, G. Andrew & Lee, Kuan-Hui & van Dijk, Mathijs A., 2012. "Understanding commonality in liquidity around the world," Journal of Financial Economics, Elsevier, vol. 105(1), pages 82-112.
    10. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    11. Michael Kearns & Alex Kulesza & Yuriy Nevmyvaka, 2010. "Empirical Limitations on High Frequency Trading Profitability," Papers 1007.2593, arXiv.org, revised Sep 2010.
    12. Hasbrouck, Joel & Seppi, Duane J., 2001. "Common factors in prices, order flows, and liquidity," Journal of Financial Economics, Elsevier, vol. 59(3), pages 383-411, March.
    13. Bruno Biais & Christophe Bisière & Chester Spatt, 2010. "Imperfect Competition in Financial Markets: An Empirical Study of Island and Nasdaq," Management Science, INFORMS, vol. 56(12), pages 2237-2250, December.
    14. Korajczyk, Robert A. & Sadka, Ronnie, 2008. "Pricing the commonality across alternative measures of liquidity," Journal of Financial Economics, Elsevier, vol. 87(1), pages 45-72, January.
    15. Rahi, Rohit & Zigrand, Jean-Pierre, 2013. "Walrasian foundations for equilibria in segmented markets," LSE Research Online Documents on Economics 62008, London School of Economics and Political Science, LSE Library.
    16. Fernando, Chitru S., 2003. "Commonality in liquidity: transmission of liquidity shocks across investors and securities," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 233-254, July.
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    Cited by:

    1. Donaldson, Jason Roderick & Micheler, Eva, 2018. "Resaleable debt and systemic risk," LSE Research Online Documents on Economics 68068, London School of Economics and Political Science, LSE Library.
    2. Donaldson, Jason & Micheler, Eva, 2016. "Resaleable debt and systemic risk," LSE Research Online Documents on Economics 66042, London School of Economics and Political Science, LSE Library.
    3. Lescourret, Laurence & Moinas, Sophie, 2014. "Liquidity Supply across Multiple Trading Venues," TSE Working Papers 14-533, Toulouse School of Economics (TSE), revised Mar 2015.
    4. Donaldson, Jason Roderick & Micheler, Eva, 2018. "Resaleable debt and systemic risk," Journal of Financial Economics, Elsevier, vol. 127(3), pages 485-504.
    5. Semyon Malamud & Marzena Rostek, 2017. "Decentralized Exchange," American Economic Review, American Economic Association, vol. 107(11), pages 3320-3362, November.
    6. Donaldson, Jason & Micheler, Eva, 2016. "Resaleable debt and systemic risk," LSE Research Online Documents on Economics 119000, London School of Economics and Political Science, LSE Library.

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    More about this item

    Keywords

    Fragmented markets; intermediation; arbitrage; liquidity; contagion;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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