The impact of upstairs trading on market quality: evidence from a highly segmented market*

Using data on over 18 million trades from the New Zealand Stock Exchange (NZX), this paper examines how market segmentation affects overall market quality in a market that until recently had no restrictions on trading outside the central limit order book (LOB). We find that upstairs trading results in lower transaction costs, larger trade size and lower volatility. A newly implemented minimum size requirement for trades in the upstairs market has the desired outcome and further lowers transaction costs and volatility due to reduced market segmentation. The results suggest that a functional upstairs market can have a positive impact on market quality if well-designed.