Liquidity, Volume, and Price Behavior: The Impact of Order vs. Quote Based Trading

We provide a three way theoretical comparison of dealer, limit order, and hybrid markets and analyze the impact that the organization of trading has on volume, liquidity, and price efficiency. We find, in particular, that trading volume is highest in the limit order market and lowest in the dealer market. Small order price impacts are lowest and large order price impacts are highest in limit order markets. Prices are most efficient in the hybrid market and least efficient in the dealer market, except when the level of informed trading is very high. Post-trade market transparency in a hybrid market hampers price efficiency for thinly traded securities. We further identify that traders behave as contrarians.liquidity, quote and order driven markets, price efficiency, hybrid markets, trading volume

Trading Volume in Dealer Markets

We develop a financial market trading model in the tradition of Glosten and Milgrom (1985) that allows us to incorporate non-trivial volume. We observe that in this model price volatility is positively related to the trading volume and to the absolute value of the net order flow, i.e. the order imbalance. Moreover, higher volume leads to higher order imbalances. These findings are consistent with well-established empirical findings. Our model further predicts that higher trader participation and systematic improvements in the quality of traders' information lead to higher volume, larger order imbalances, lower market depth, shorter duration, and higher price volatility.Market Microstructure, Trading Volume, Liquidity

Subsidizing Liquidity: The Impact of Make/Take Fees on Market Quality ∗

In recent years most equity trading platforms moved to subsidize the provision of liquidity. Under such a make/take fee structure, submitters of limit orders typically receive a rebate upon execution of their orders, and the exchange covers its costs by charging a higher fee for market orders. Trading rebates have, arguably, been a major facilitator for the emergence of algorithmic trading. We study the impact of this, now prevalent, fee structure on market quality, market efficiency, and trading activity by analyzing the introduction of liquidity rebates on the Toronto Stock Exchange. Using a proprietary dataset, we find that the liquidity rebate structure leads to decreased spreads, increased depth, increased volume, and intensified competition in liquidity provision. Explicitly accounting for exchange fees and rebates, we further find that trading costs for market orders did not decrease and that per share revenues for liquidity providers increase, despite the reduced bid ask spreads and increased competition. Finally, we find no evidence for changes in intermediation or market efficiency. JEL Classification: G12, G14