FINTECH THRUST SEMINAR | Dual Trading, Fee Competition, and Price Discovery at the Market Close

Dual Trading, Fee Competition, and Price Discovery at the Market Close

Abstract: 

We empirically study how ‘’dual-traders,’’ whose only information comes from order flow of their clients, affect price discovery. Dual traders partly infer the asset's value from clients' order flow and exploit it in simultaneous or subsequent trading. In our empirical setting, closing auctions have high transaction fees and large pricing errors due to the growing trading demand of passive investors. Brokers offer alternative trading venues that charge lower transaction fees, guarantee execution at closing auctions' prices, and dual trade. Using a quasi-experimental shock -- the NYSE closing auction fee cut -- we find that the alternative venues reduced the pricing errors in market close prices. We explain the finding with a model where liquidity provided by dual traders mitigates the impact of market maker's overnight inventory cost on price efficiency.