美联储-谁在照看商店？零售交易执行中的订单路径与竞争 Who is Minding the Store Order Routing and Competition in Retail Trade Execution

FinanceandEconomicsDiscussionSeries

FederalReserveBoard,Washington,D.C.

ISSN1936-2854(Print)

ISSN2767-3898(Online)

WhoisMindingtheStore?OrderRoutingandCompetitioninRetailTradeExecution

XingHuang,PhilippeJorion,JeongminLee,andChristopherSchwarz

2024-080

Pleasecitethispaperas:

Huang,Xing,PhilippeJorion,JeongminLee,andChristopherSchwarz(2024).“WhoisMindingtheStore?OrderRoutingandCompetitioninRetailTradeExecution,”FinanceandEconomicsDiscussionSeries2024-080.Washington:BoardofGovernorsoftheFederalReserveSystem,

/10.17016/FEDS.2024.080

.

NOTE:StafworkingpapersintheFinanceandEconomicsDiscussionSeries(FEDS)arepreliminarymaterialscirculatedtostimulatediscussionandcriticalcomment.TheanalysisandconclusionssetfortharethoseoftheauthorsanddonotindicateconcurrencebyothermembersoftheresearchstafortheBoardofGovernors.ReferencesinpublicationstotheFinanceandEconomicsDiscussionSeries(otherthanacknowledgement)shouldbeclearedwiththeauthor(s)toprotectthetentativecharacterofthesepapers.

1

WhoIsMindingtheStore?OrderRoutingandCompetitioninRetailTradeExecution

XingHuang,PhilippeJorion,JeongminLee,andChristopherSchwarz*,tJuly20,2024

Abstract

Using150,000actualtrades,westudytheU.S.equityretailbroker-wholesalermarket,focusingonbrokers’orderroutingandcompetitionamongwholesalers.Wedocumentsubstantialandpersistentdispersioninexecutioncostsacrosswholesalerswithinbro-kers.Despitethis,manybrokershardlychangetheirroutingandevenconsistentlysendmoreorderstothemoreexpensivewholesalers,althoughthereisconsiderablevariationamongbrokers.Wealsodocumentacasewhere,afteranewwholesalerenters,existingwholesalerssignificantlyreducetheirexecutioncosts.Overall,ourfindingsandtheo-reticalframeworkhighlighttheheterogeneityacrossbrokersandareinconsistentwithperfectcompetitioninthismarket.

*ChristopherSchwarz(correspondingauthor,phone:949-824-0936,email:cschwarz@)andPhilippeJorionareatthePaulMerageSchoolofBusinessattheUniversityofCaliforniaatIrvine.XingHuangisattheOlinBusinessSchool,WashingtonUniversityinSt.Louis.Jeongmin“Mina”LeeisattheFederalReserveBoard,Washington,DC.Theviewsexpressedherearetheauthors’ownanddonotreflecttheviewsoftheFederalReserveSystemoritsstaff.WewishtothankAlyssaMoncriefandSanathNairforresearchassistance.Thispaperbenefitedfromhelpfulcommentsbynumerousfriendsandcolleaguesandconferenceparticipantsatthe2023ESSFMAssetPricingConference,2024MFAConference,2024NortheasternUniversityFinanceConference,SFSCavalcade2024,9thAnnualUniversityofConnecticutFinanceConference,10th“WomeninMicrostructure”Meeting(WiMM),aswellasseminarsatBaruchCollege,ColumbiaUniversity,CornellUniversity,IowaStateUniversity,JohnsHopkinsUniversity,theUniversityofMaryland,NortheasternUniversity,andNotreDameUniversity.Inparticular,wewantedtothankAmberAnand,FatemehAramian,ThomasErnst,DermotMurphy,MehrdadSamadi,ChesterSpatt,MaoYe.Allerrorsareourown.

tAllbrokerageaccountsreferencedwerefundeddirectlybytheauthorswithpersonalmoney.Nooutsidecompensationwasreceivedfromanybrokerorwholesalerforthisstudy.Thispaperrequirednooutsideapproval.JeongminLeedidnotandwillnotcontributeanyfundsorinputtothedesignandexecutionoftrading.SinceJeongminLeeandherspouseanddependentchildrenarenotparticipatinginanyformtothetradingprocess,thepaperdoesnotviolateanyethicsrulesorBoardpolicies.

JELClassifications:G12,G14,G50

Keywords:retailtrading,executionquality,orderrouting,competition,marketmicrostructure,regulation,

broker-dealers,wholesalers

1

1.Introduction

Retailinvestors’accesstoequitymarketshasvastlyimprovedoverthelastfewdecades.IntheU.S.,theadoptionofRegulationNMS(

SEC

(

2005

))ledmostretailbrokerstoroutecustomers’orderstospecializedOTCmarketmakers,called“wholesalers.”Inexchangeforretailorderflows,wholesalersprovidedirectcompensationtomostbrokers,calledpaymentfororderflow(PFOF),andindirectlycompensateinvestorsthroughreducedeffectivebid-askspreadsrelativetothosequotedonexchanges,whichisalsoknownas“priceimprovement.”Further,mostretailbrokerseliminatedcommissionsinlate2019.Thesechangesledtomajorreductionsintradingcosts.Evenso,tradingisnotfree,andtheactualcostsinvestorsincuraredeterminedbytheexecutionqualityprovidedtoretailinvestors.

Inthispaper,westudybrokers’orderroutingandwholesalercompetitiontoprovideinsightintotheexecutionqualityofretailtrades

.1

Ontheonehand,thereareonlyfourmajorplayerscurrently(Citadel,Virtu,G1X,andJaneStreet),whichraisesaconcernthatthewholesalermarketistooconcentratedandhasledtoscrutinyfrompolicy-makers

.2,3

Ontheotherhand,brokersmightbeabletoenforceprice(Bertrand)competitionamongwholesalers.Althoughbrokersdonothaveadirecteconomicstakeinexecutioncosts(whichareentirelybornebyinvestors),theydohavealegaldutyof“bestexecution.”Brokersare

1AnotherelementthatcanaffecttheexecutionqualityisPFOF.However,theliterature(e.g.,

Bartlett

etal.

(2023),

Ernstetal.

(2024),

Levy

(2022),

Schwarzetal.

(2023))haslargelyfoundthatPFOFisnot

relatedtoexecutionqualityforU.S.equitiesandthattheeconomicmagnitudeofPFOFmaybetoosmalltoexplainlargevariationsinexecutionquality.Inaddition,PFOFisthesameacrosswholesalerswithinbrokers,whichshouldnotinfluenceroutingdecisions.

2

HuandMurphy

(2022)arguethatthetwolargestwholesalersinthismarketaccountfor70%ofvolume

. 3In2022,theSECissuedfourproposalsthatwouldfundamentallyrevisetheregulationsgoverningthestructureofU.S.equitymarkets.Theproposedchangesinclude:“DisclosureofOrderExecutionInforma-

tion”(

SEC

(2022a)),whichwasrecentlyadopted(

SEC

(2024)),“OrderCompetitionRule”(

SEC

(2022b)),

“RegulationBestExecution”(

SEC

(2022c)),and“RegulationNMS:MinimumPricingIncrements,Access

Fees,andTransparencyofBetterPricedOrders”(

SEC

(2022d))

.

2

expectedtomonitorthequalityofwholesalerexecutiontoensurethat“orderflowisdirectedtomarketsprovidingthemostbeneficialtermsfortheircustomers’orders”(

FINRA

(

2014

)).

Usingover150,000independently-generatedtrades,wefindresultsinconsistentwithper-fectpricecompetitioninthismarket.MeasuringexecutioncostsaseffectivespreadsdividedbyquotedNBBOspreads(E/Q),wefindsignificantandpersistentdifferencesincostsacrosswholesalersforeachbroker.Moreover,wefindsubstantialheterogeneityintheresponsesofbrokerstopastexecutionquality,withthemajorityofbrokerscontinuingtosendmoreorderstomoreexpensivewholesalers.Lastly,wedocumentacasewhereexistingwholesalerssignificantlylowerexecutioncostsfollowingtheentryofanewwholesaler.Ourtheoreticalframeworkbasedonprice(Bertrand)competitionwithfrictionscollectivelyexplainsourresults.

TradingExperiment.Ratherthanrelyingonpublicdisclosuresthatareaggregatedatahighlevel,weprovideauniquewindowintothisdebatebyusingdatafromanearlytwo-yearlongtradingexperiment.Weplacedtradesonrandomlyselectedstocksatrandomtimesacrossmultiplebrokerageaccounts

.4

Toprovideacontrolledcomparisonacrossbrokers,tradesareplacedinaparallelmanner(i.e.,tradesinthesamestockofthesameordersizeatthesametime).Thissetupisessentialforthefollowingreasons.First,randomizationofourtradescanmitigatetheselectionbiasthatcouldarisefrompotentialstrategicbehaviors

4Wegeneratedatotalofapproximately150,000trades,equivalentto$22.4millioninnotional,overtheperiodfromDecember21,2021,toMay31,2023.OurtradesareexecutedthroughE*Trade,Fidelity,InteractiveBrokers(IBKR,withboththeirProandLiteaccounttypes),Robinhood,Schwab,andTDAmeritrade.Weplacedordersatdifferentbrokersthatwereidenticalintype(marketorders),ticker/symbol(stock),size(dollarsandsharestraded),direction(buyorsell),andsubmissiontime(randomizedacrossbrokers.)Alltradeswereintraday,i.e.,weboughtequitiesafterthemarketopenedandthensoldthemwithin30minutes,withtradingspreadoutthroughouttheday.

3

ofwholesalers

.5

Second,ourapproachallowsustodirectlyconductwithin-brokercompar-isonofexecutioncosts.Focusingondispersionwithinbrokerisimportantsincetherearelargevariationsofexecutioncostsacrossbrokers

(Battalioetal.

(2001)and

Schwarzetal.

(2023))

.Third,becausebrokersmayhaveheterogeneouscriteriaformakingroutingchoices,havingawiderangeofbrokersallowsustoexaminehowdifferentroutingchoicesaffectthecompetitivenessofthewholesalermarketplace.

Ourtradesarebasedonsmallmarketorders

.6

Althoughweshowthatourfindingsarerobusttoalimitedsampleofround-lotorders,wewanttocautionthatouranalysismaybemoreapplicabletounderstandinghowbrokershandlesmallorders,ratherthantheentireorderflow

.7

Nevertheless,smallordersarebecomingincreasinglyimportant

.8

Weconsiderthatthissegmentcanstillprovidevaluableinsightsforhighlightingtherichheterogeneityinthebehaviorofbrokersandwholesalersanduncoveringtheeconomicmechanismsinthisimportantandgrowingmarket

.9

Interestingly,wefindthatbrokersemploytwodistinctroutingstyles.Approximatelytwo-thirdsofourbrokersroutestockstowholesalersusingwhatwecall“proportional”routing.Thesebrokerssimplytakea“slice”oftheiraggregateorderflow,randomizedacrossstocks,

5Wholesalersmighttailortheirexecutionqualitytobrokers’evaluationmetricsthatareverynarrow.Consequently,usingarchivalorpublicdisclosuredatamayinadvertentlybiasthesampletowardsinstanceswherestrategicwholesalersapparentlyoffersuperiorexecution.Ourapproach,incontrast,shouldprovideamoreunbiasedanalysis.

6Eachorderiseitherworthapproximately$100or1sharewhenthestockpriceexceeds$100.

7Moregenerally,weareonlyexaminingonesegmentofabroker’sorderflow.Differentsegments,whethersortedbyspread,size,orothersecuritycharacteristics,maylooksimilarordifferentdependingonthebroker’sexactroutingcriteria.

8Asinvestorsarespreadingoutlargetradesovertime,andsmaller-sizedtradeshavebecomeanaturalresponsetotheabolitionoffixedcommissionsperorder,oddlots(i.e.,lessthan100shares)nowaccountfor60%ofordersandcloseto20%oftradingvolume.Thisprevalenceislikelyevengreateramongretailtradesandhigh-pricedstocks(See

/marketstructure/datavis/ma_overview.html

).Withinourrandomsampleofstocks,oddlotsarealsothesecondlargestsizebinintermsoftotalquotedspreaddollarvolume.

9Inaddition,anumberofauthors,suchas

O’Haraetal.

(2014)and

Bartlettetal.

(2023),haveemphasized

theimportanceofoddlotsintermsofhiddenquotes,aswellaspricediscoveryinformativeness.

4

andsendittoeachwholesaler;theonlyvariationacrosswholesalersisthedollarsizeofeachslice.Incontrast,theremainingone-thirdofbrokersusewhatwecall“selective”routing(“smart-routing”inindustryparlance),wheretheroutingforeachindividualstockisselectedfromstockcharacteristicsaswellastheobservedwholesalerexecutionquality.

MainResults.Ourthreemainresultstestimplicationsofperfectprice(Bertrand)com-petitionandfindotherwise.First,underperfectcompetition,wewouldexpectminimaldis-persioninexecutioncostsacrosswholesalersforanygivenbrokersincemostordersshouldgotowholesalerswithsuperiorexecutionwhenbrokersfrictionlesslyswitchacrosswholesalersbasedonexecutionquality.Instead,wefindasubstantialdispersion.Foragivenbroker,thegapbetweenthemaximumandminimumexecutioncostsvariesfrom42%to151%ofthebrokers’average.Thedispersionismorepronouncedamongproportionalbrokers(70%to151%ofthebroker’saverage)comparedtoselectivebrokers(42%to58%ofthebroker’saverage).Moreover,thisdispersionispersistentbothattheaggregateandstocklevels,implyingthatwithin-brokerexecutionqualityishighlypredictableovertime.

Second,underperfectcompetition,wewouldexpectbrokerstoadjusttheirroutingbasedonexecutionquality,shiftingmarketsharetowardswholesalerswithsuperiorexecution.Instead,despitesignificantandpersistentdispersion,wefindthatproportionalbrokershardlychangetheirroutingbasedonpastexecution,whileselectivebrokersdo.Wealsostudyhowthelevel(notthechange)ofmarketsharerelatestopastexecution.Surprisingly,thereisapositiverelationbetweenmarketshareandpastexecutionforproportionalbrokers,whiletherelationshipflipstonegativeforselectivebrokers.Thus,proportionalbrokersconsistentlyallocatealargerfractionofourorderstomoreexpensivewholesalers.Toillustratethe

5

economicimpactofbrokers’limitedadjustments,wesimulatedynamicroutingstrategiesbasedonpastexecution,directingallorderstothelowest-costwholesalerfromthepreviousmonth.OurhypotheticalroutinglowersE/Qby34%onaverage,withreductionsrangingfrom33%to60%forproportionalbrokersandfrom8%to14%forselectivebrokers.

Third,ifmarketswereperfectlycompetitive,wewouldexpectminimalchangesinexe-cutioncostsfollowingtheentryofanewwholesaler,astheexistingmarginswouldnotallowsignificantreductions.Instead,wedocumentacasewithsignificantreductionsinexecutioncostsamongincumbentwholesalers.JaneStreetenteredasanewwholesalerforRobinhood,ourmostresponsiveselectivebroker,duringoursampleperiodinearly2022.Immediatelyafterthisentry,wefindthatincumbentwholesalersloweredE/Qby14%onaverage,withreductionsvaryingfrom2%to26%

.10

Overall,ourthreemainfindingsshowthatbrokers’responsestoexecutionqualityvarysubstantiallyandareoftenlimitedwhenhandlingsmall,odd-lotorders.Additionally,itappearsthatthereisinsufficientcompetitionamongwholesalers,evenwhenbrokersareresponsive.Theseresultssuggestthatretailinvestorswouldbenefitfrommoreresponsivebrokerroutingandincreasedwholesalercompetition.

TheoreticalFramework.Wedevelopastylizedmodelofprice(Bertrand)competitionwithfrictionstoexplainthepuzzlingresultrevealedbyourempiricalanalysis:proportionalbrokersexhibitapositiverelationbetweenmarketshareandpastexecutioncost,consistentlysendingalargerfractionoftheirorderstomoreexpensivewholesalers.

Inthemodel,abrokeroptimallyroutesorderstotwowholesalers.Torepresentthe

10Thelargeimpactofentrysuggestssignificantbarrierstoentryinthewholesalermarket(e.g.,

Goolsbee

andSyverson

(2008))

.

6

observedlimitedbrokerresponsestoexecutiondifferences,weassumethatthebrokerfacesquadraticswitchingcostswhenchangingmarketsharesacrosswholesalers.Theseswitchingcostsmayrepresentvariousfrictionsthatlimitthebroker’sabilitytoadjustitsrouting

.11

Thepuzzlingpositiverelationbetweenmarketshareandexecutioncosts,observedamongproportionalbrokers,naturallyemergesinequilibrium.Theintuitionisthatthebrokers’limitedadjustmentsgivewholesalerssomescopeforexercisingmarketpower,suchthatthosewithlargermarketsharesalsochargehigherexecutioncosts

.12

Discussion.Wediscussthreemainpoints.First,weshowhowbrokerprioritiesacrossdifferentsegmentscanbeincorporatedintoourtheoreticalframework.Ifabrokerprioritizesonesegmentoveranother,wholesalersrespondbyloweringexecutioncostsfortheprioritizedsegmentandincreasingthemfortheother.Thisresultsinanequilibriumwherethebrokereffectivelyhashigherswitchingcostsforthenon-prioritizedsegment.Thus,switchingcostscanbebroadlyinterpretedtoreflectbrokerpriorities,aswellasvariousreal-worldfrictions.

Second,weexplorehowvaryingcharacteristicsofbrokerorderflows,suchasordertoxi-city,mayexplaintheheterogeneityinaverageexecutionacrossbrokers.Undertheuniformstandard(NBBO)enforcedbyregulation,brokerswithmoretoxicorderflowsandhigherwholesalers’marginalcostsfaceincreasedregulatorypressure,incentivizingthemtochoosesmallerswitchingcosts.Theendogenouschoiceofswitchingcostshelpsexplainapuzzlingrelationshipobservedinthedata:selectivebrokerswithlowerswitchingcoststendtohavehigher(ratherthanlower)overallexecutioncosts.

11Thefrictionsmayincludethetimeandcostsassociatedwithmonitoringexecutionqualityandimple-mentingcomplexroutingchanges,managerialandorganizationalinertia,thedesiretosupplystableorderflowstowholesalers,andsoon.

12Anextensionaccountingforheterogeneousmarginalcostsacrosswholesalersgeneratesanegativerela-tionbetweenmarketshareandexecutioncosts,consistentwithourfindingsforselectivebrokers.

7

Lastly,weexaminehowbrokerheterogeneitycancomplicatetheinterpretationofag-gregatepublicdisclosuresandprovideimplicationsfordisclosurepolicies.Ourdatashowthatwholesalerswithlowerexecutioncostsattractmoreordersfrombrokershandlingmoretoxicorderflows,leadingtohigheroverallexecutioncostsforthesebrokers.Thiscompli-catescomparisonsofexecutioncostsacrosswholesalers.Therefore,detailed,disaggregateddataatthebroker-wholesalerleveliscrucialforaccuratelyassessingwholesalerperformance.Implementingthesepublicdisclosureswouldlikelyincreasepressureonbrokerstoimprovemonitoringandroutingpractices,potentiallyincreasingcompetition

.13

RelatedLiterature.Ourpaperismostcloselyrelatedto

Dyhrbergetal.

(2023)and

Ernstetal.

(2023)

.14

Thesepapersarecomplementarytooursandofferusefulinsightsfromdifferentdatasourcesthatalsocontributetoabetterunderstandingofthismarket.

Dyhrbergetal.

(2023)studythecompetitivenessofthebroker-wholesalermarketplace

usingpublic605formsbymarketcenters,whichprovideexecutioncostsatthewholesalerlevel.Theyfindthatmarketshareandexecutioncostsarenegativelyrelated,orthatthelargestwholesalersofferthelowestexecutioncosts.TheyalsoclaimthatJaneStreet’sentryintothemarketdidnotcausecompetitorstochangetheirpricing,whencomparingtwofixedwindowsaroundJuly2021.

13Undertherecentlyadopteddisclosurerequirements(

SEC

(2024)),the605forms(disclosuresoforder

executioninformationbymarketcenters)willnowalsoberequiredforretailbrokers,notjustwholesalers,andextendedtooddlots.However,theproposalstilldoesnotrequiredisclosingexecutioncostsforeachbroker-wholesalerpair.FordetailsonForm605,see“DisclosureofOrderExecutionInformation”(

SEC

(2005))

.

14

Bartlettetal.

(2023)comparewholesalerexecutionqualitytothatonexchangesandshowthatwhole

-salerexecutionisconsistentlysuperiortoexchanges.Otherwise,previousworkonexecutionqualityhasmostlyfocusedondifferentmarketcentersandtypesoftrades.However,themarketenvironmenthasdras-ticallychangedsincetheadventofzerocommissionsin2019.Forexample,

Battalioetal.

(2016)and

Battalio

(2018)usedatafrom2012and2016,respectively,toexaminefeesandrebatesonexchanges,whererebates

applytolimitorders.

8

Despiteusingdifferentdatasources,weareabletoreplicatetheirmainempiricalfindings.However,ourinterpretationsaremorenuancedbasedonmoregranulardata.Wehighlightbrokerheterogeneityandfindthattherelationbetweenmarketshareandexecutioncostsis,infact,positiveforproportionalbrokers.Wealsofindthatthelower-costwholesalersattractmoretoxicorderflows,complicatingthecomparisonofexecutionqualitybasedonaggregateexecutioncostsduetoSimpson’sparadox.Finally,theentryofJaneStreetoccurredatdifferentpointsintimeforvariousbrokers.Ourdetaileddataallowsustoisolateonespecific(selective)broker,wherewefindsignificantreductionsinexecutioncostsaftertheentry.

Ernstetal.

(2023)studywhetherbrokersimplementbestexecutionusingproprietary

dataprovidedbythreeanonymousbrokers.Theyfindthatbrokersrespondtowholesalerexecutionandthatwholesalersrespondtothebroker’schangeinpriorities.Theirfindingsonbrokerresponsivenessgenerallyalignwithourresultsforselectivebrokersbutnotforproportionalbrokers.

Therearethreemaindifferencesthatmayexplainthis.First,themeasureofwholesalerexecutionisdifferent.Weconsistentlyuseequal-weightedE/Qofourindependentlygener-atedtradesforallbrokers.Theyusedifferentmetricsforeachbrokerbasedontheirowncriteria,includingdifferentsecuritybins,sizecategories,andaproprietaryscoremetric.

Second,thebrokersamplesdiffer.Wehavesixdifferentbrokers(fourproportionalandtwoselective).Theyhavethreeanonymousbrokerswhovoluntarilyprovidetheirdata(onlyoneoftheirbrokersappearstobeproportional).Giventhestarkheterogeneityacrossbrokers,alargersampleofbrokersprovidesabroadercomparisonoforderroutingpracticesacrosstheindustry.Additionally,relyingonavoluntarilydisclosedsamplemaybiasresults

9

towardbetterresponsiveness.

Third,ourdatafocusesonsmall,odd-lottrades,whiletheirdataincludesabroaderrangeofordersizes.Thisimpliesthepossibilitythatournon-responsiveproportionalbrokersmaystillrespondtowholesalerexecutionoflarger,round-lottrades.InSection

6.1

,wediscusshowbrokersprioritizingdifferentsegmentsoforderflowcanleadtovaryingresponsivenessacrosssegmentsandhowthiscanbeincorporatedintoourtheoreticalframework.

Ourpaperisalsorelatedto

Ernstetal.

(

2024

)whoprovideasystematiccomparisonofthecurrent,status-quobroker-routingmarketsystemversusthe

SEC

(

2022b

)proposed“OrderCompetitionRule”(OCR),whichwouldrelyonorder-by-orderauctionsinstead.Theauthorsassumethatcompetitionisensuredinthestatus-quomodelbecausebrokersshouldmonitorexecutioncloselyandrouteordersbasedoneachmarketmaker’saggregateperformance.Inpractice,wefindthatthisisnotnecessarilythecase.

Moregenerally,ourpaperisrelatedtotheindustrialorganizationliterature.Numer-ousstudiesshowhowmarketoutcomesreflecttheexerciseofmarketpowerinaspecificindustry.

15

Here,wefocusonthebroker-wholesalermarket.Weuseswitchingcosts,whichhavebeenlongusedintheliterature,

16

asamodelingdevicetorepresentbrokers’limitedadjustmentsandconnectthemtomarketpowerofwholesalers.Wealsohighlighttheroleofregulationsinprovidingheterogeneousandinsufficientincentivesforbrokerstoreduceswitchingcosts,limitingcompetition.Thisconnectstoearlierstudieslike

Daughety

(1984),

whichshowhowsettingthesamepriceforallfirmsinanindustrycanleadtoinefficiencies.

Therestofthepaperisorganizedasfollows.Section

2

reviewstheinstitutionalback-

15Seeforexample

Porter

(1983),

Bresnahan

(1987),and

Nevo

(2001)

.

EinavandLevin

(2010)providea

comprehensivesurveyoftheempiricalindustrialorganizationliterature,includingstudiesonmarketpower.

16Priorliteraturemostlyfocusesonconsumerbehavior,e.g.,

Klemperer

(1987),

FarrellandKlemperer

(2007)

.

10

ground,inparticularinteractionsbetweenbrokersandwholesalers.Section

3

thendescribesourindependently-generateddataandpatternsintheroutingofindividualstocksfrombro-kerstovariouswholesalers.Next,Section

4

delvesintoourempiricalanalysisaimedatevaluatingthedegreeofcompetitivenessinthewholesalerindustry.Section

5

thenpresentsastylizedmodelexplainingourempiricalfindings,whileSection

6

providesadditionalinter-pretationandimplicationsofouranalysis.Section

7

concludes.

2.InstitutionalBackground

Startinginlate2019,almostallretailbrokerswentcommissionfree,followingRobin-hood’sexamplein2015.Thiswasmadepossiblebecausebrokerscouldroutetheirretailtradesoffexchanges,directlytowholesalersthatexecutetrades,withgenerallybetterpricingforclients.Fromthebrokers’perspective,thissetupcannotonlyprovidePaymentforOrderFlow(PFOF)revenues,butitalsohelpsthemfulfilltheirbestexecutionrequirements

.17

Interestingly,therelationbetweenbrokersandwholesalersisratherloose,reflectingthenatureoftheirprivatearrangements

.18

First,thebrokerselectsapoolofwholesalersthatsatisfyitsduediligencerequirements.Thebrokerthensetsalevelofpaymentfororderflow,whichcanbezero.Itisimportanttonotethatthebrokertypicallysets“level”,oridentical,PFOFratesacrosswholesalersinordertoavoidconflictsofinterestinroutingdecisions.Next,thewholesalercandecidewhethertoacceptornotthebroker’sorders.Therearenoothercontractualobligations:brokerscanrouteorderstoanymarketcenters,

17OneconcernisthatPFOFcouldpotentiallyleadtoworseexecutionforretailtradersduetoitsinherentconflictofinterest.However,recentresearch(e.g.,

BattalioandJennings

(2023),

Ernstetal.

(2024),and

Schwarzetal.

(2023))haslargelyshownthatPFOFdoesnotsignificantlyimpactpriceexecutionforequity

trades.WeshouldnotethatPFOFhasbeencommonfordecades,althoughtoamuchlesserextentthannowadays.

18

Schwab

(2022),forexample,providesanoverviewoforderroutingp