| By: |
Johannes A. Skjeltorp (Norges Bank (Central Bank of Norway));
Elvira Sojli (Erasmus University and Duisenberg school of nance);
Wing Wah Tham (Erasmus University and Tinbergen Institute) |
| Abstract: |
We study the relevance of the cross-sided externality of liquidity between
market makers and takers from the two-sided market perspective and test the
empirical implications of the Foucault, Kadan, and Kandel (2012) model. We use
exogenous changes in the make/take fee structure and a technological shock for
liquidity takers, as experiments to identify cross-sided complementarities
between liquidity makers and takers in the U.S. equity market. We find
positive cross-sided externalities between liquidity providers and takers.
Using the estimate of the externality from the instrumental variable
regression, we find that the loss in revenue due to the increased
subsidization of liquidity demanders from a fee change in a trading venue
exceeds the increase in trading rate and revenue from the positive cross-sided
liquidity externality. Our findings highlight the importance of accounting for
participation externalities in the pricing strategy of trading venues. Our
findings also shed light on the way the order-posting behavior of market
makers and takers is interrelated and contribute to the on-going policy debate
on the maker/taker practices in U.S. equity markets. |
| Keywords: |
Liquidity cycle, liquidity externality, Two-sided markets; Make/take fees |
| JEL: |
G10 G20 G14 |
| Date: |
2012–12–18 |
| URL: |
http://d.repec.org/n?u=RePEc:bno:worpap:2012_20&r=mst |