Competition in Securities Markets : The Impact on Liquidity

Competition for order flow is widely documented for U.S. markets, but is a relatively new phenomenon in European equities trading. Only with the Markets in Financial Instruments Directive, which went into effect in November 2007, did new trading venues emerge in Europe that for the first time ever seriously threatened established exchanges. Chi-X, one of the new competitors, has gained a considerable market share, eroding the traditional exchanges' share of equities trading volumes. As the proliferation of new trading venues in Europe increases the danger of market fragmentation, this paper analyzes the potentially positive liquidity implications of a new trading venue. To this end, we examine the impact of the Chi-X market entry in French blue-chip equities on the liquidity of their home market. Our findings suggest that in consequence of the new competitor's market entry, liquidity in the most actively traded stocks was enhanced on the home market during the observation period. This improvement exceeds the general European liquidity trend measured by a matching firm approach, which implies that despite fragmentation of order flow, market quality may even be enhanced