Liquidity plays a crucial role in financial exchange markets. Markets typically create liquidity through spatial consolidation with specialist/market makers matching orders arriving at different times. However, continuous trading systems have an inherent weakness in the potential for insufficient liquidity. This risk was highlighted during the 1987 market crash. Subsequent proposals suggested time consolidation in the form of call markets integrated into the continuous trading environment. This paper explores the optimal fee schedule for a monopolist call market auctioneer competing with a continuous auction market. Liquidity is an externality in that traders are not fully compensated for the liquidity they bring to the market. Thus, in the absence of differential transaction costs, traders have an incentive to delay order entry resulting in significant uncertainty in the number of traders participating at the call. A well-designed call market mechanism has to mitigate this uncertainty. The trading mechanism examined utilizes two elements: commitments to trade and discounts in fees for early commitment; thus, optimal transaction fees are time-dependent. Traders who commit early are rewarded for the enhanced liquidity that their commitment provides to the market. As participants commit earlier they pay strictly lower fees and are strictly better off by participating in the call market rather than in the continuous market. A comparison to the social welfare maximizing fee schedule shows that the monopolist does not internalize the externality completely, with the social welfare maximizing schedule offering lower fees to all traders.

We thank Bill Silber, Jarl Kallberg, Bob Schwartz, Joel Owen, and seminar participants at New York University for comments and suggestions.

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