DP11591 Strategic Fragmented Markets

Author(s): Ana Babus, Cecilia Parlatore Siritto
Publication Date: October 2016
Date Revised: March 2017
Keyword(s): demand schedule equilibrium, interdealer trading, market fragmentation
JEL(s): D43, D47, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11591

We study the determinants of asset market fragmentation. We develop a model of market formation with strategic investors that have heterogeneous valuations for an asset. Investors choose a dealer with whom to trade considering their price impact and the liquidity provided by the dealer. Fragmented markets are supported in equilibrium when investors? valuations are sufficiently correlated. In this case, liquidity provision is scarce and investors are more willing to accept a higher price impact. Dealers can benefit from fragmentation, but investors are always better off in centralized markets. Market fragmentation contributes to lower trading volumes relative to a centralized market.