Order flow fragmentation and flight-to-transparency during stressed market conditions: Evidence from COVID-19

The proliferation of trading venues has resulted in a fragmented secondary markets landscape both in the US and Europe. Different factors drive the fragmentation of order flow during normal market conditions. This paper studies the composition of order flow during stressed market conditions based on the COVID-19 outbreak. We specifically investigate two related questions. Firstly, we assess whether stressed market conditions alter the level of fragmentation and, secondly, we study the choice of lit vs. dark trading when markets are under stress. As for the first question, we construct a measure to capture order flow fragmentation and find that fragmentation strongly decreases when markets are under stress (i.e., traders concentrate their order flow in fewer venues in times of market stress). This is especially the case for stocks experiencing a deeper shock in volatility. As for the second question, we find a migration of order flow from dark to lit venues when markets are under stress. Our interpretation of this finding is that traders tend to move to lit venues, where the probability of trading with an informed trader is less severe, during times of hyper-volatility. We call this evidence 'flight-to-transparency'.