Fragmentation and Consolidation of Order Books

Abstract

Since the implementation of MiFID on November 1 2007 European financial markets have experienced fragmentation in displayed (lit) order books as well as an increase in the use of non-displayed (dark) liquidity. We empirically analyze the effects such events have on market quality. We find that increased competition for orders resulting from the fragmentation of the displayed liquidity market improves market quality in the form of tighter bid/ask spreads and lower transaction costs, with institutional investors realizing greater benefits than retail investors. Fragmentation between lit and dark order books has a negative impact on market quality as informative trades migrate from lit to dark order book markets leading to greater information asymmetry among market participants. This results in wider bid/ask spreads and greater price impacts as investor confidence in advertised prices decreases and depth moves further from the midpoint of the best bid/ask spread. Increased dark order book fragmentation negatively effects market quality in the form of wider quoted spreads, however the magnitude of the affect is minimal. We also find that while the number of dark trading venues increases over time, the number of unique order dark books, which take into consideration liquidity sharing, remains fairly constant. This indicates that markets can effectively regulate the number of viable dark trading venues.

Date of Award	14 Feb 2015
Original language	English
Supervisor	Julia Henker (Supervisor)