Market structure, fragmentation, and market quality

This paper studies the impact of order flow fragmentation on market quality. Due to differences in market structure, order flow becomes more consolidated when stocks switch listings from a dealer market (NASDAQ) to an exchange (NYSE). We find that the post-switch improvements of market quality are related to the degree of order flow fragmentation on NASDAQ as well as the change of fragmentation after trading on the NYSE. After controlling and correcting for potential selection bias arising from a nonrandom sample, we find that order flow fragmentation affects market quality as predicted by finance theories. Our paper shows that order flow consolidation is particularly valuable for less liquid securities.