Liquidity Cycles and Make/Take Fees in Electronic Markets

We develop a model in which the speed of reaction to trading opportunities is endogenous. Traders face a trade-off between the benefit of being first to seize a profit opportunity and the cost of attention required to be first to seize this opportunity. The model provides an explanation for maker/taker pricing, and has implications for the effects of algorithmic trading on liquidity, volume, and welfare. Liquidity suppliers and liquidity demanders trading intensities reinforce each other, highlighting a new form of liquidity externalities. Data on durations between trades and quotes could be used to identify these externalities.

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