Market Fragmentation and Market Quality: The European Experience

This book chapter provides an overview of market fragmentation in Europe since the first implementation of the Markets in Financial Instruments Directive (MiFID) on 1 November 2007. It makes a brief literature review on the consequences of lit and dark fragmentation for liquidity. It presents an empirical analysis of the effect of market fragmentation on price quality measured by price inefficiency coefficients (PICs) based on variance ratios for a sample of European large and medium capitalizations stocks. Contrary to the results by O'Hara and Ye (2011) for U.S. stocks, I do not find a clearly significant impact of market fragmentation on price quality. The only PICs to be affected are those based on 1-second to 5-second return variance ratios. According to 1-second to 5-second PICs: (1) the price quality of large UK equities improved with market fragmentation after MiFID; (2) the price quality of large Euronext equities improved with fragmentation in the primary market but deteriorated when measured across markets; and (3) the price quality of Euronext mid-caps was adversely affected. Notwithstanding these findings, price quality is not affected when measured at any other horizon