Abstract
Stock exchanges compete for order flow through their fee models. A traditional model pays rebates to liquidity suppliers, and an inverted model pays rebates to liquidity demanders. Using a regulatory intervention to examine the interaction between tick size, restrictions on dark trading, and exchange fees we show that traders use inverted venues to adjust for suboptimal tick sizes. Increased inverted venue activity improves pricing efficiency and liquidity, especially when the tick size is binding. We show that the sub-tick price improvement offered by inverted venues enhances competition for liquidity provision and increases information impounded into prices through non-marketable limit orders.
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