Liquidity Fragmentation and Migration within the Same Exchange

• Main Author: TING, Hian Ann, Christopher
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2006
• Subjects: Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/774
• Institution: Singapore Management University

Liquidity fragmentation occurs when traders have choices in trading fungible securities. This article documents the migration of Dow futures’ liquidity from the pit to the electronic market. The implied spread declines dramatically for electronic trades as volume increases over a sample period from April 2002 through December 2004. This implicit cost, despite dwindling volume, does not increase for trades in the pit but drops by about $13 per trade. This somewhat surprising result suggests that competition for order flows brings about positive externality within the same exchange. Seller-initiated trades tend to have higher costs on both trading platforms. The implicit cost difference between a buyer-initiated trade and a seller-initiated trade is economically significant. Relative to the implied spread, the average difference is about 13 to 17% for futures traded outside of the regular hours and 3.4 to 12% per trade during the regular hours of cash market.