Dynamic Order Submission Strategies with Competition between a Dealer Market and a Crossing Network

We present a dynamic microstructure model where a dealer market (DM) and a crossing network (CN) interact. Sequentially arriving agents with different valuations for an asset maximize their profits either by trading at a DM or by submitting an order for (possibly) uncertain execution at a CN. We develop the analysis for three different informational settings: transparency, “complete” opaqueness of all order flow, and “partial” opaqueness (with observable DM trades). A key result is that the interaction of trading systems generates systematic patterns in order flow for the transparency and partial opaqueness settings. The precise nature of these patterns depends on the degree of transparency at the CN. While unambiguous with a transparent CN, they may reverse in direction if the CN is opaque. Moreover, common to the three informational settings, we find that a CN and a DM cater for different types of traders. Investors with a high willingness to trade are more likely to prefer a DM. The introduction of a CN next to a DM also affects welfare as it increases total order flow by attracting traders who would otherwise not submit orders (“order creation”); in addition, it diverts trades from the DM (“trade diversion”). We find that the coexistence of a CN and DM produces greater trader welfare than a DM in isolation. Also, more transparent markets lead to greater trader welfare but may reduce overall welfare.