Competition for Order flow and Price Discovery: The Curious case of High-tech Entrants

The quality of ultra-high frequency quotes submitted to an entrant high-tech market (BATS Chi-X Europe – Chi-X) is compared to those of an established national exchange (London Stock Exchange – LSE). There are intraday variations regarding which platform impounds new information about the fundamental value of stocks into their prices fastest such that both markets alternate price leadership over the day and across high and low volume stocks. The variations in price leadership are consistent with the effects of informed trading, liquidity and institutional trading arrangements on both platforms, but inconsistent with the theoretical liquidity-price efficiency link. Dark and algorithmic trading are shown to generally impede price discovery for lower volume stocks on Chi-X, while the effect of algorithmic trading is found to be generally positive for LSE stocks’ price discovery. Despite the variations in intraday price leadership, Chi-X accounts for more share of price discovery than is suggested by its comparatively lower share of transactions; crucially, this strong showing in the price leadership contest is critical to its gaining of market share at the expense of the LSE.