Competition and Integration Among Stock Exchanges in Europe: Network Effects, Implicit Mergers and Regulatory Considerations

Abstract

The economic theory of network externalities and a simple-game theoretical framework are used to explore the issue of competition among stock exchanges and the possibility of consolidation in the European stock-exchange industry, among the different exchanges. The main features of this paper are the following: the treatment of exchanges as firms; the application of network externalities to study competition among exchanges; the extension of network externalities, through implementing 'cross-network' effects; and the existence of equilibria where exchanges may decide, even unilaterally, to achieve full compatibility through implicit mergers and remote access, specializing only in trading or listing services. One implication is that consolidation of European exchanges into one may occur with a welfare-efficient outcome or with a lock-in to a Pareto-inferior equilibrium. This is due to the network externalities and the different starting points of the various exchanges. 'Implicit mergers' among exchanges together with remote access are always weakly (in half of the cases, strictly) more efficient than the actual competition. This finding also sheds light on the existence and efficacy, especially in the U.S., of automated trading systems, which are exchanges specializing in trading services.

Keywords: Securities Exchanges, Competition, Implicit Merger, Network Effect, Remote Access

JEL Classification: C71, D43, F36, G15