Fragmentation and stability of markets

Abstract

Trading skills are highly rewarded in practice but largely ignored in theoretical models of financial markets. This paper demonstrates the importance of skills by exploring their interaction with market fragmentation and market stability. We consider a computational model where traders' abilities to accurately price assets are endogenous. In contrast to models that do not consider skills, we find that centralising markets can lead to poorer price discovery and less resilience to shocks because it increases the equilibrium proportion of unskilled traders.