Alejandro Bernales, Nicolas Garrido, Satchit Sagade, Marcela Valenzuela, and Christian Westheide
By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our modelâ€™s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.