Market Fragmentation and Price Discovery on the London Stock Exchange

Since the 1997 reform FTSE 100 stocks trade on the London Stock Exchange in a fragmented market. These stocks can be traded either on the electronic order book, SETS, or through dealers posting voluntary quotations. The UK regulator does not enforce any quote display requirement, and best execution requirements are satisfied when prices for off-SETS trades are at least as good as the prices available on SETS. In this environment, dealers may have an informational advantage over public traders with no corresponding obligation and this may lead to a free riding problem and inefficient prices. Our results are consistent with this conjecture. In particular, price changes are mainly explained by SETS trades which seem more informative than off-book trades. Off-book trading adversely affects price efficiency because it delays the price discovery process. JEL Classification: G10, G34