We study the empirical relevance of the participation externality between liquidity suppliers (makers) and demanders (takers), i.e., whether liquidity demand attracts or reduces liquidity supply, and vice versa. We use exogenous shocks to exchange fees and technology as experiments to identify cross-sided complementarities between liquidity suppliers and demanders in the U.S. equity market. We find that the externality is large and positive, on average. However, the externality is negative in periods of high adverse selection. We quantify the economic significance of the externality by evaluating an exchange’s revenue after a fee change.

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Keywords Liquidity cycle, Liquidity externality, Make/take fees, Two-sided markets
Persistent URL dx.doi.org/10.1287/mnsc.2016.2658, hdl.handle.net/1765/108742
Journal Management Science
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Tham, W.W, Sojli, E, & Skjeltorp, J.A. (2018). Cross-sided liquidity externalities. In Management Science (Vol. 64, pp. 2901–2929). doi:10.1287/mnsc.2016.2658