Market Fragmentation in Europe
Available through Plato Partnership
Abstract: The European equity trading landscape of 2022 is a complex mix of exchanges, dark pools, dealers, and auctions. The once dominant national stock exchanges are now part of global exchange groups that compete with investment banks and high-frequency trading (HFT) firms to match the orders of retail and institutional investors. Is this diverse trading environment in the best interests of investors? Academic research has taken on this question from many angles, both theoretically and empirically. This paper surveys the findings of the market fragmentation literature, with a special focus on European equity market quality. I discuss why markets fragment, what the potential market quality effects are, and what this implies for the European context. The objective is to provide a concise review that captures the implications for current policy in Europe.
Determinants of Limit Order Cancellations
(with Petter Dahlström and Lars Nordén).
Abstract: We investigate the economic rationale behind limit order cancellations from the perspective of liquidity suppliers. We predict that an order is cancelled whenever its expected revenue no longer exceeds the expected cost and we model how order profitability variation can be determined from changes in the state of the order book and the order queue position. Our empirical evidence supports the predictions in general and for orders submitted by high-frequency trading firms in particular. Consistent with our model approach, we find that order cancellation patterns are more consistent with market making than with liquidity demand strategies.
(with Albert Menkveld and 341 other coauthors).
Abstract: In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in sample estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: non-standard errors. To study them, we let 164 teams test six hypotheses on the same sample. We find that non-standard errors are sizeable, on par with standard errors. Their size (i) co-varies only weakly with team merits, reproducibility, or peer rating, (ii) declines significantly after peer-feedback, and (iii) is underestimated by participants.
Mid-Day Call Auctions
(with Jonathan Brogaard and Caihong Xu)
Abstract: In illiquid and fragmented limit order book markets, asynchronously arriving buyers and sellers have a coordination problem. This problem is particularly strong mid-day, when trading is generally thin. We evaluate a market structure reform at Nasdaq Nordic, where the continuous trading session is replaced mid-day by a five-minute call auction. We find that the mid-day call auction works as a coordination device, reducing transitory price impact. The call auction attracts end investors rather than intermediaries. Stocks with greater end investor flows show stronger benefits of the call auction. The results indicate that mid-day auctions can improve continuous markets.
Resting working papers
Does Commonality in Illiquidity Matter to Investors?
(with Richard Anderson, Jane Binner, and Birger Nilsson)
Published 2013 as a Federal Reserve Bank of St Louis Working Paper
Abstract: This paper investigates whether investors are compensated for taking on commonality risk in equity portfolios. A large literature documents the existence and the causes of commonality in illiquidity, but the implications for investors are less understood. In a more than fifty year long sample of NYSE stocks, we find that commonality risk carries a return premium of at least 2.0 per cent annually. The commonality risk premium is statistically and economically significant, and substantially higher than what is found in previous studies. It is robust when controlling for illiquidity level effects, transaction costs, as well as variations in illiquidity measurement.
Best Execution: Can Institutional and Retail Investors Benefit from Fast and Fragmented Trading?
(with Michał Dzieliński and Lars Nordén)
Asian Finance Association Best Paper Award 2016
Abstract: Fast trading and fragmentation of volume make equity markets complex, leading retail and institutional investors to demand sophisticated brokerage services. In a sample of stock transactions in Swedish large-cap firms, we find that brokers who show high trading sophistication when trading their own book do not deliver comparable execution quality when trading on behalf of clients. Best execution legislation states that brokers should take all reasonable steps to maximize the execution quality when trading on behalf of clients. For institutional clients, the shortcoming in execution quality is primarily driven by brokers’ inability to route the transactions to the trading venue with the best price. For retail clients, in contrast, the shortcoming is due to poor liquidity timing and a strong reliance on active executions. Only institutional block trades benefit from execution by sophisticated brokers.