Market Fragmentation: Liquidity, Price Discovery, and Welfare

We analyze the impact of financial market fragmentation when traders differ in terms of market access and information about the asset payoff. Agents who cannot operate on all trading venues are hurt by fragmentation. Those who can trade globally can benefit. Overall liquidity peaks at an intermediate level of fragmentation; price informativeness continues to improve until a higher level. A larger investor base and less information asymmetry widen the scope for beneficial fragmentation, while greater multi-venue access narrows it. The model explains the observed non-monotonic relationship between fragmentation and liquidity, and the differential impact on large-cap versus small-cap stocks.

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