Fragmentation and Strategic Market-Making

Laurence Daures Lescourret and Sophie Moinas

How does trading in one venue affect the quoting strategies of market-makers in other venues? We develop a two-venue imperfect competition model in which market-makers face quadratic costs to absorb shocks. Non-constant marginal costs imply that absorbing a shock in one venue simultaneously changes marginal costs in all other venues. Moreover, market-makers strategically choose which shock(s) to absorb. These two forces may intensify competition, leading to enhanced liquidity. Using Euronext proprietary data, we track individual best bid and ask quotes of intermediaries in each venue. We uncover evidence of strategic cross-market quoting behavior which is uniquely predicted by our model.