Abstract:
Two forces have reshaped global securities markets: Exchanges operate at much faster speeds and the trading landscape has become more fragmented. In order to analyze the implications of these evolutions, we study a framework that captures (i) exchanges’ incentives to invest in faster platforms and (ii) investors’ trading and participation decisions. We find that speed competition reduces asset prices. Regulations that protect investors (e.g. SEC’s trade-through) reduce prices further and lead to more fragmentation and faster speeds. Endogenizing speeds can also change the slope of asset demand curves. On normative side, for a given number of exchanges, speed investments are generally socially desirable. Competition among exchanges increases participation and welfare for a given trading speed, but is not necessarily desirable when speeds are endogenous. Our model sheds light on the experience of European and U.S. markets since the implementation of MiFID and Reg. NMS, and provides guidance for optimal regulations.

Pagnotta, Emiliano and Philippon, Thomas, Competing on Speed (April 27, 2012). Available at SSRN: http://ssrn.com/abstract=1967156 or http://dx.doi.org/10.2139/ssrn.1967156

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