Why Discrete Price Fragments U.S. Stock Exchanges and Disperses Their Fee Structures

Stock exchange operators compete for order flow by setting "make" fees for limit orders and "take" fees for market orders. When traders quote continuous prices, they can choose prices that perfectly neutralize any fee division, and traders stream to the exchange with the lowest total fee. The one-cent minimum tick size (minimum price variation) for traders prevents perfect neutralization. The two-sided price competition (i) allows an exchange operator to establish exchanges that differ in fee structure to engage in second-degree price discrimination; and (ii) destroys the Bertrand equilibrium, leads to frequent fee changes, and encourages the entry of new exchanges