Securities Market Structure, Trading Fees and Investors' Welfare.

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Abstract
We consider a riskless asset (a "zero coupon bond") that trade on a dealer (OTC) market or a limit order market. In the limit order market, investors can choose to be "makers" (post limit orders) or "takers" (hit limit orders) whereas in the dealer market they must trade at dealers' quotes. Moreover, in the limit order market, investors pay a trading fee to the operator of this market ("the matchmaker"). We show that, for some parameter values, an increase in the matchmaker's trading fee can raise investors' ex-ante expected welfare. Actually, it forces makers to post more aggressive offers and thereby it raises the likelihood of a direct trade between investors. Thus, a reduction in the matchmaker's trading fee (due for instance to increased competition) can counter-intuitively raise the OTC market share and impair investors' welfare. However, investors are always better off with a zero trading fee rather than the fee set by a for-profit monopolist matchmaker. Finally, the model has testable implications for the effects of a change in trading fees on various measures of market liquidity.

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