On the Effects of Continuous Trading

The continuous limit order book, in which messages are processed one by one in the order of receipt, is a prominent design feature of modern securities markets. Theoretical models show that this design imposes a cost on liquidity providers and suggest that this cost may be reduced by switching to batch auctions. We examine a recent opposite move, whereby a stock exchange switches from batch auctions to continuous trading. Consistent with theoretical predictions, we find that the move leads to greater adverse selection. Trading costs increase as a result, while displayed liquidity deteriorates.