Is Best Really Better? Internalization in Xetra Best
32 Pages Posted: 5 Apr 2005
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: Suggested Citation
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