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The pros and cons of market fragmentation, Price dispersion - Coggle…
The pros and cons of market fragmentation
Cons
Higher trading costs for the investors
Reduce risk sharing among investors
Harder for traders to infer informed
investors's information
Quotes are not centralized therefore investors need to do more searching for the best prices
Prevent the investors from taking the advantage of "liquidity
externalities" which means that more traders in one market increase the liquidity and decrease trading fees.
Fragmentation is a source of illiquidity
Because of information asymmetry an informed trader expects larger profits than a trader that has less information. Hence, the increased profits of the informed trader in the fragmented market come at the expense of liquidity traders
Market fragmentation hinders competition among liquidity providers, by weakening interactions between market makers active in different liquidity pools and thereby decreasing their incentives to offer good quotes.
Informational effects
May harm price discovery
Regulations
MiFID
It may lead to "dysfunctional market" (ex. the best ask price in one platform is lower than the best bid price in another one)
May lead to different (or the same) prices at the same moment across various venues
Complicates the relationship between brokers and investors
Conflict of interests for Brokers', as they might have monetrary inducements for routing orders to specific markets or dealers
Clients often lack expertise to verify the broker strategy
Degryse et al. (2014)
The Impact of Dark Trading and Visible Fragmentation on Market Quality
Dark fragmentation
Liquidity deteriorates by "competition for order flow"
(Dark markets) attract uninformed order flow which in turn increases adverse selection costs in the visible markets
Pros
Enhances "competition for order flow"
Competition among liquidity providers, within different platforms
Increase consolidated liquidity
One benefit of intermarket competition is that different trading needs of investors can be best served by different trading mechanisms.
Competition between trading platforms
Foster technological innovation
Reduction of trading fees
If there's only a single trading venue, it might set its fees at a monopolistic level
Degryse et al. (2014)
The Impact of Dark Trading and Visible Fragmentation on Market Quality
Visible Fragmentation
liquidity improves by competition of order flow
regulations
Price dispersion