Would Order-by-Order Auctions Be Competitive?

Retail trading flow is segregated from non-retail flow in U.S. equities, consistent with market segmentation. We model theoretically two methods of executing segregated retail trades: a) broker's routing, whereby brokers evaluate and allocate orders based on each market maker's aggregate performance, and b) order-by-order auctions, where market makers bid on each individual order, a market structure suggested recently by the SEC leadership. We find that order-by-order auctions improve allocative efficiency among market makers, but a winner's curse problem in the auction can reduce retail investor welfare, particularly at times of limited liquidity. Empirical analysis of Retail Liquidity Programs (RLP) currently offered by exchanges shows that these programs behave similarly to order-by-order auctions in our model.