Publication Type
Journal Article
Version
publishedVersion
Publication Date
4-2024
Abstract
We study liquidity supply in fragmented markets. Market makers intermediate heterogeneous order flows, trading off spread revenue against inventory costs. Applying our model to payment for order flow (PFOF), we demonstrate that portfolio-based considerations of inventory management incentivize market makers to segment retail orders by siphoning them off-exchange. Banning order flow segmentation reduces total welfare, can make trading more costly for all investors, and can resolve a prisoner's dilemma among market makers. These results differentiate our inventory-based model from the existing information-based theories of PFOF.
Keywords
Inventory management, Market making, Order flow segmentation, Payment for order flow, Retail trading
Discipline
Finance and Financial Management | Portfolio and Security Analysis
Research Areas
Finance
Publication
Journal of Financial Economics
Volume
154
First Page
1
Last Page
23
ISSN
0304-405X
Identifier
10.1016/j.jfineco.2024.103807
Publisher
Elsevier
Citation
BALDAUF, Markus; MOLLNER, Joshua; and YUESHEN, Bart Zhou.
Siphoned apart: A portfolio perspective on order flow segmentation. (2024). Journal of Financial Economics. 154, 1-23.
Available at: https://ink.library.smu.edu.sg/lkcsb_research/7480
Copyright Owner and License
Authors
Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.
Additional URL
https://doi.org/10.1016/j.jfineco.2024.103807