Cross-Sided Liquidity Externalities

We study the empirical relevance of the participation externality between liquidity suppliers (makers) and demanders (takers), i.e., whether liquidity demand attracts or reduces liquidity supply, and vice versa. We use exogenous shocks to exchange fees and technology as experiments to identify cross...

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Bibliographic Details
Published in:Management Science 2018, Vol.64 (6), p.2901
Main Authors: Tham, Wing Wah, Sojli, Elvira, Skjeltorp, Johannes A
Format: Report
Language:English
Subjects:
Externalities (Economics)
Financial research
Liquidity (Finance)
Stock markets
Online Access:Get full text
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Summary:We study the empirical relevance of the participation externality between liquidity suppliers (makers) and demanders (takers), i.e., whether liquidity demand attracts or reduces liquidity supply, and vice versa. We use exogenous shocks to exchange fees and technology as experiments to identify cross-sided complementarities between liquidity suppliers and demanders in the U.S. equity market. We find that the externality is large and positive, on average. However, the externality is negative in periods of high adverse selection. We quantify the economic significance of the externality by evaluating an exchange's revenue after a fee change.
ISSN:0025-1909
DOI:10.1287/mnsc.2016.2658