For NYSE spreads set by the specialist, a basis for the competition hypothesis is that increases in off board volume, for a given total volume, reduce NYSE trading volume, causing the specialist to narrow NYSE spreads in an attempt to retain some of the volume that otherwise would be lost to off board market makers.
For NYSE spreads set by limit orders, changes in the flow of limit orders associated with changes in off board volume can affect the direction of the change in NYSE spreads.
For NYSE spreads set by limit orders, a basis for the fragmentation hypothesis is that increases in off board trading volume, for a given total volume, reduce NYSE trading volume, which may increase NYSE spreads if the total limit order flow to the NYSE is reduced.
In this study, we focus on how changes in off board trading volume affect NYSE spreads when the spreads are more likely the result of limit orders or more likely set by the specialist.
The impact that a change in off board volume will have on NYSE spreads, for a given total volume, depends partly on how the proportion of market orders to limit orders changes on the NYSE.
it]) = the log of total volume traded on the NYSE and off board for stock i, on day t
it]) = the log of total volume traded off board for stock i, on day t
2] is total volume both on and off board, since the objective is to determine whether changes in off board volume, for a given total volume, produce a competition or fragmentation effect on NYSE spreads.
Second, the ISSM data allows direct comparison of NYSE and off board trading, since it contains all quotes and transactions recorded on the NYSE as well as regional exchanges and the third market.
3] = 0 is the null hypothesis that changes in off board volume have no affect on NYSE spreads.