Working Paper: NBER ID: w17652
Authors: Emiliano Pagnotta; Thomas Philippon
Abstract: Two forces have reshaped global securities markets in the last decade: Exchanges operate at much faster speeds and the trading landscape has become more fragmented. In order to analyze the positive and normative implications of these evolutions, we study a framework that captures (i) exchanges' incentives to invest in faster trading technologies and (ii) investors' trading and participation decisions. Our model predicts that regulation that protect prices will lead to fragmentation and faster trading speed. Asset prices decrease when there is intermediation competition and are further depressed by price protection. Endogenizing speed can also change the slope of asset demand curves. On normative side, we find that for a given number of exchanges, faster trading is in general socially desirable. Similarly, for a given trading speed, competition among exchange increases participation and welfare. However, when speed is endogenous, competition between exchanges is not necessarily desirable. In particular, speed can be inefficiently high. Our model sheds light on important features of the experience of European and U.S. markets since the implementation of Reg. NMS, and provides some guidance for optimal regulations.
Keywords: trading speed; market fragmentation; regulation; investor welfare
JEL Codes: G12; L13; L15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Regulation protecting prices (E64) | fragmentation (F12) |
| Regulation protecting prices (E64) | faster trading speeds (G14) |
| faster trading speeds (G14) | investor participation (G24) |
| faster trading speeds (G14) | investor welfare (G24) |
| Competition among exchanges (D41) | participation (D16) |
| Competition among exchanges (D41) | welfare (I38) |
| Intermediation competition (L13) | asset prices (G19) |
| Price protection (D18) | investor behavior (G41) |
| Price protection (D18) | market entry decisions (F23) |
| Competition among exchanges (D41) | inefficiencies (D61) |
| Excessive entry and speed choices (R41) | suboptimal welfare outcomes (D69) |