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Research Details

Siphoned Apart: A Portfolio Perspective on Order Flow Segmentation, Journal of Financial Economics

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 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.

Type

Article

Author(s)

Markus Baldauf, Joshua Mollner, Bart Zhou Yueshen

Date Published

2023

Citations

Baldauf, Markus, Joshua Mollner, and Bart Zhou Yueshen. 2023. Siphoned Apart: A Portfolio Perspective on Order Flow Segmentation. Journal of Financial Economics.

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