Volume 15 | Issue 1 | Article 1
Next Article >>
Back To: Table of Contents
Liquidity Externality and Migration within the Same Security Exchange
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.
