A Decade in the Life of a Market: Visible Market Fragmentation, Quality and Efficiency
43 Pages Posted: 14 Mar 2016 Last revised: 16 May 2016
Date Written: April 11, 2016
In contrast to the Reg NMS regime in the US, the European Markets in Financial Instruments Directive (MiFID) does not impose a formal exchange trading linkage or guarantee the best execution price. This raises concerns about consolidated market quality in an increasingly fragmented European trading environment. We investigate the impact of visible trading fragmentation on equity market quality on FTSE 100 stocks over the period 2004 to 2014. We find a U-shape relationship between fragmentation and adverse selection costs. At lower levels of fragmentation, order flow competition reduces adverse selection costs and improves market transparency. However, there is a fragmentation threshold where implied adverse selection costs could increase with visible fragmentation. Visible fragmentation also stimulates market efficiency by reducing arbitrage opportunities.
Keywords: MiFID, Multilateral Trading Facilities (MTFs), Market Transparency, Adverse Selection, Probability of informed trading (PIN), Market Efficiency
JEL Classification: G10, G14, G15
Suggested Citation: Suggested Citation