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Trader Competition in Fragmented Markets: Liquidity Supply versus Picking-off Risk

Author

Listed:
  • Bernales, Alejandro
  • Garrido, Nicolás
  • Sagade, Satchit
  • Valenzuela, Marcela
  • Westheide, Christian

Abstract

By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.

Suggested Citation

  • 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.
  • Handle: RePEc:zbw:safewp:234
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    References listed on IDEAS

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    Cited by:

    1. Daniel Chen & Darrell Duffie, 2020. "Market Fragmentation," NBER Working Papers 26828, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Fragmentation; Competition; Liquidity; Price Efficiency;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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