Segmented Trading Markets
54 Pages Posted: 1 Jun 2022 Last revised: 11 Dec 2023
Date Written: May 1, 2022
Abstract
We study competition and endogenous fragmentation among heterogenous trading venues that differ in technology (fast vs. slow), where traders can dynamically choose which venue to trade in. We show that technological improvements increase trading speed, but may also heighten differentiation, which reduces competition, leads to higher trading fees, and potentially reduces trading volume and welfare. Improvements in the slower venue lead to increased trading speed, decreased differentiation, and thus increased trading volume and welfare. Conversely, the effect of improvements in the faster venue is generally ambiguous and depends on the extent of traders’ patience, the frequency of their preference shocks, and the competition between venue owners. We further study the effect of technological improvement in one of the venues when both initially have the same trading speed. We find that if the trading speeds are initially slow enough, the technological improvement will increase trading volume and trader welfare. Conversely, if the trading speeds are initially fast, the increase in trading fees outweighs the speed advantage that comes with technological improvement, leading to decreased trading volume and trader welfare.
Keywords: OTC vs Exchange. Heterogeneous venues. Fragmentation. Competition.
JEL Classification: G12, G2, D4, L13.
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