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RFS Advance Access published online on January 5, 2005
Review of Financial Studies, doi:10.1093/rfs/hhi013
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The Review of Financial Studies © The Society for Financial Studies 2005; all rights reserved.

Original Articles

Island Goes Dark: Transparency, Fragmentation, and Regulation

Terrence Hendershott 1* and Charles M. Jones 2
1 Haas School of Business, University of California at Berkeley
2 Graduate School of Business, Columbia University

* To whom correspondence should be addressed.
Terrence Hendershott, E-mail: hender{at}haas.berkeley.edu


  Abstract

Responding to regulatory enforcement in September 2002, the Island electronic communications network stops displaying its limit order book in the three most active exchange-traded funds (ETFs) where it is the dominant venue. Island's share of trading activity and price discovery falls, fragmenting the market. ETF prices adjust more slowly when Island goes dark, and substantial price discovery moves from ETFs to the futures market. Trading costs increase on Island and decrease off Island, with higher trading costs overall. When Island later redisplays its orders, market quality improves, with transparency and the reduction in fragmentation both playing important roles.


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