Working Paper: NBER ID: w26828
Authors: Daniel Chen; Darrell Duffie
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 cross-exchange 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.
Keywords: No keywords provided
JEL Codes: D47; D82; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fragmentation (F12) | Traders split orders across different exchanges (G15) |
| Traders split orders across different exchanges (G15) | Reduces price impact of orders (G19) |
| Reduces price impact of orders (G19) | Increases total order submission (C69) |
| Fragmentation (F12) | More aggressive overall order submission (C69) |
| Degree of fragmentation increases (F12) | Equilibrium allocation becomes more efficient (D61) |
| Equilibrium allocation becomes more efficient (D61) | Until a certain threshold is reached (C69) |
| Further fragmentation (F12) | Leads to excessive trading aggressiveness (G41) |
| Individual exchange prices less informative (P22) | Aggregate prices across all exchanges provide more information (E30) |