Multi-Market Trading and Liquidity: Theory and Evidence

In this paper, we develop and test a theoretical model of multi-market trading to explain the differences in the foreign share of trading volume of internationally cross-listed stocks. The model derives an equilibrium which predicts that, under fairly general conditions, the distribution of trading volume across exchanges competing for order flow is related to the correlation of the cross-listed asset returns that arise in the respective markets. That is, volume migrates to the exchange in which the cross-listed asset returns have greater correlation with returns of other assets traded on that market. We test this prediction with monthly stock returns and volume data on 275 non-U.S. stocks cross-listed on major U.S. exchanges. We find strong empirical support for the prediction, even after controlling for other firm-specific, issue-specific and country-level factors.