Splitting orders

A standard presumption of market microstructure models is thatcompetition between risk-neutral market makers inevitably leadsto price schedules that leave market makers zero expected profitsconditional on the order flow. This article documents an importantlack of robustness of this zero-profit result. In particular,we show that if traders can split orders between market makers,then market makers set less-competitive price schedules thatearn them strictly positive profits and hence raise tradingcosts. Thus, this article can explain why somebody might willinglymake a market for a stock when there are fixed costs to doingso. The analysis extends to a limit order book, which by itsnature is split against incoming market orders: equilibriumlimit order schedules necessarily yield those agents positiveexpected profits.