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Market Power on Exchanges: Linking Price Impact to Trading Fees

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  • Sarah Draus

    (Rotterdam School of Management, Erasmus University, and CSEF)

Abstract

Recent regulations, aimed at making trading and exchange services more competitive, triggered the proliferation of competing trading venues and resulted in high order flow fragmentation. This paper demonstrates that fragmentation allows liquidity providers and exchanges to retain market power. Whenever exchanges are not completely liquid, a rational trader fragments his order to reduce price impact. This lowers the price elasticity of both liquidity provider’s asset demand and exchange trading volume, inducing mark-ups on transaction prices and on exchange trading fees. Surprisingly, less competitive liquidity provision feeds back into higher trading fees. Moreover, exchanges with better liquidity charge higher trading fees and attract larger market shares. The results are consistent with anecdotal evidence and deliver empirical implications for the effect of introducing exchange competition on implicit and explicit trading costs.

Suggested Citation

  • Sarah Draus, 2012. "Market Power on Exchanges: Linking Price Impact to Trading Fees," CSEF Working Papers 490, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    • Handle: RePEc:sef:csefwp:490
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    More about this item

    Keywords

    stock exchanges; competition; order fragmentation; trading fee; liquidity; regulation.;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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