Is Best Really Better? Internalization of Orders in an Open Limit Order Book

Schmalenbach Business Review, Vol. 64, April 2012, pp. 82-100

19 Pages Posted: 14 Apr 2012

See all articles by Joachim Grammig

Joachim Grammig

University of Tübingen

Erik Theissen

University of Mannheim - Finance Area

Date Written: April 1, 2012

Abstract

We study the market quality of the Xetra BEST system operated by Deutsche Börse AG, an internalization system designed as part of an open limit order book, which guarantees a price improvement over the inside spread in the Xetra order book. We develop a structural model of this dual market environment and show that adverse selection costs of internalized trades are significantly lower than those of regular order book trade while realized spreads are significantly larger. The cost savings of the internalizer are larger than the mandatory price improvement, suggesting that internalization can be profitable for both customer and internalizer.

Keywords: Adverse Selection Costs, Execution Quality, Internalization

JEL Classification: G10

Suggested Citation

Grammig, Joachim and Theissen, Erik, Is Best Really Better? Internalization of Orders in an Open Limit Order Book (April 1, 2012). Schmalenbach Business Review, Vol. 64, April 2012, pp. 82-100, Available at SSRN: https://ssrn.com/abstract=2039222

Joachim Grammig (Contact Author)

University of Tübingen ( email )

Mohlstrasse 36
72074 Tübingen, Baden Wuerttemberg 72074
Germany

Erik Theissen

University of Mannheim - Finance Area ( email )

Mannheim, 68131
Germany

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