Is Best Really Better? Internalization in Xetra Best

32 Pages Posted: 5 Apr 2005

See all articles by Joachim Grammig

Joachim Grammig

University of Tübingen

Erik Theissen

University of Mannheim - Finance Area

Date Written: March 2005

Abstract

Xetra BEST, operated by Deutsche Borse AG as a part of the Xetra trading system, allows participating banks and brokers to internalize retail customer orders. This paper provides an empirical assessment of the market quality of Xetra BEST. For this purpose, we develop a trade indicator model of this dual market structure with an open order book and an internalization system that guarantees a mandatory price improvement over the inside spread of the book. We show that internalization is profitable, and that adverse selection costs of internalized trades are significantly lower than those of regular order book trades. However, the mandatory price improvement for internalized trades does not fully compensate for the difference in adverse selection costs. Our results imply that measures aimed at increasing competition among internalizers may yield improved execution quality for internalized orders.

Keywords: Internalization, execution quality, adverse selection costs

JEL Classification: G10

Suggested Citation

Grammig, Joachim and Theissen, Erik, Is Best Really Better? Internalization in Xetra Best (March 2005). Available at SSRN: https://ssrn.com/abstract=695842 or http://dx.doi.org/10.2139/ssrn.695842

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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