Two-Sided Markets, Make-Take Fees and Competition between Stock Exchanges
Event details
| Date | 09.01.2015 |
| Hour | 10:30 › 12:00 |
| Speaker | Mao YE (University of Illinois) |
| Location | |
| Category | Conferences - Seminars |
This paper examines competition between stock exchanges for order flow by setting make fees for limit orders and take fees for market orders. We find that exchanges can use make-take fees to create sub-tick prices and facilitate trades that are blocked by the tick size regulation. The discrete tick size generates two-sided markets in which the charge on each side matters even for the same total charge. Our two-sided market model explains several anomalies relative to a standard one-sided market. First, the breakdown of make-take fees is not neutral for social welfare, and the equilibrium fee structure always involves one side being subsidized and the other side being charged. Second, the price competition of two identical exchanges does not lead to Bertrand outcome, but to mixed strategy equilibrium with positive profits. This justifies the diversity of fee structures and their frequent adjustments, as well as the entry of exchanges with new fee structures. Third, the model predicts that liquidity makers prefer being charged (subsidized) when the tick size is large (small), and the market becomes more fragmented under a larger tick size. We find empirical evidence consistent with these two predictions using reverse splits of ETFs as exogenous shocks to the relative tick size, with paired ETFs that track the same index but do not reverse split as controls.
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