Market Fragmentation
-
Daniel Chen
-
Darrell Duffie
- American Economic Review (Forthcoming)
Abstract
We model a simple market setting in which fragmentation of
trade of the same asset across multiple exchanges improves allocative
efficiency. Fragmentation reduces the inhibiting effect of
price-impact avoidance on order submission. Although fragmentation
reduces market depth on each exchange, it also isolates crossexchange
price impacts, leading to more aggressive overall order
submission and better rebalancing of unwanted positions across
traders. Fragmentation also has implications for the extent to
which prices reveal traders’ private information. While a given
exchange price is less informative in more fragmented markets, all
exchange prices taken together are more informative.
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