The Impact of Fragmentation, Exchange Fees and Liquidity Provision on Market Quality

We analyse the impact of two major financial frictions on market quality in a high-frequency environment: market fragmentation and exchange fees. We find fragmentation significantly improves market quality, with benefits increasing with greater fragmentation. Fragmentation significantly reduces spreads for stocks that are least constrained by the minimum tick size, whilst constrained stocks experience significant increases in depth. These changes are driven by the entry of fee-sensitive electronic liquidity providers (ELPs). Consistent with theoretical predictions, we find reductions in exchange trading fees are passed through to market participants. The main improvement in market quality, however, is driven by the entry of new ELPs who benefit from cross-venue market making strategies