Splitting Orders

REVIEW OF FINANCIAL STUDIES, Vol. 10 No. 1

Posted: 9 Apr 1997

See all articles by Dan Bernhardt

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Eric N. Hughson

Claremont McKenna College - Robert Day School of Economics and Finance

Abstract

A standard presumption of market microstructure models is that competition between risk-neutral market makers inevitably leads to price schedules that leave market makers zero expected profits conditional on the order flow. This paper documents an important lack of robustness of this zero-profit result. In particular, we show that if traders can split orders between market makers, then market makers set less competitive price schedules that earn them strictly positive profits and hence raise trading costs. Thus, this paper can explain why somebody might willingly make a market for a stock when there are fixed costs to doing so. The analysis extends to a limit order book, which by its nature is split against incoming market orders: equilibrium limit order schedules necessarily yield those agents positive expected profits.

JEL Classification: G12, G14

Suggested Citation

Bernhardt, Dan and Hughson, Eric N., Splitting Orders. REVIEW OF FINANCIAL STUDIES, Vol. 10 No. 1, Available at SSRN: https://ssrn.com/abstract=8261

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-5708 (Phone)

Eric N. Hughson (Contact Author)

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909-607-3664 (Phone)

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