A Match in the Dark: Understanding Crossing Network Liquidity

Abstract

I model the decision of whether or not to use a crossing network (CN) or a traditional quoting exchange (QE) and derive hypotheses regarding the factors that affect this decision. I test these hypotheses on realized CN volumes and find that the likelihood of using CNs increases and then decreases with increasing relative bid ask spread and other measures of market liquidity. These findings are consistent with the model and reflect two countervailing effects: (1) increased savings on spread related transaction costs on CNs and (2) concerns regarding gaming when QE prices are more easily manipulated. Gaming concerns also decrease the consistency of volume on CNs. Additionally, I find that CN use increases with information asymmetry and the difficulty of disguising informed trading on QEs. In addition to providing empirical support for the model, these findings inform the debate on CN regulation and suggest that gaming is likely to inhibit CN growth.

Keywords: Crossing networks, exchanges, gaming, liquidity

JEL Classification: D53, G12, G28