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Discussion Paper Details

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Title: Liquidity cycles and make/take fees in electronic markets

Author(s): Thierry Foucault, Ohad Kadan and Eugene Kandel

Publication Date: November 2009

Keyword(s): algorithmic trading, duration clustering, Liquidity, make/take fees, monitoring and two-sided markets

Programme Area(s): Financial Economics and Industrial Organization

Abstract: We develop a dynamic model of a market with two specialized sides: traders posting quotes ("market makers") and traders hitting quotes ("market takers"). Traders monitor the market to seize profit opportunities, generating high frequency liquidity cycles. Monitoring decisions by market-makers and market-takers are self-reinforcing, generating multiple equilibria with differing liquidity levels and duration clustering. The trading rate is typically maximized when makers and takers are charged different fees or even paid rebates. The model yields several empirical implications regarding the determinants of make/take fees, the trading rate, the bid-ask spread, and the effects of algorithmic trading on liquidity and welfare.

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Bibliographic Reference

Foucault, T, Kadan, O and Kandel, E. 2009. 'Liquidity cycles and make/take fees in electronic markets'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7551