Strategic Intermediation in Liquidity Markets

We develop a model of competition between two exchanges, which we view as platforms on which liquidity is demanded and supplied. The model has a single financial asset, and features competitive liquidity suppliers, a liquidity demander, and two kinds of strategic intermediaries. The first kind is an HFT that can act as a strategic intermediary between the competitive suppliers and the liquidity demander. The second kind is a broker who has the technology to determine optimal order routing across the exchanges. Each exchange earns revenue by charging make fees to liquidity suppliers and take fees to liquidity demanders. We highlight how the make-take fees on each exchange affect the strategies of the HFT and the broker, and thus the properties of each exchange such as volume and spread. We present empirical evidence on the importance of fee splits.