Liquidity fragmentation during geopolitical shocks arises from interactions among market participants, venue rules, and information flows. At the microstructural level, several features make fragmentation worse by encouraging liquidity to concentrate, withdraw, or migrate across trading venues.
Market microstructure drivers
Key factors include shallow order book depth, wide bid-ask spreads, and high order cancellation rates. Maureen O'Hara at Cornell documents how information asymmetry raises spreads and reduces displayed depth, which in turn causes liquidity providers to retreat. Joel Hasbrouck at New York University Stern shows that when traders expect adverse selection, they shift to less visible trading venues or withdraw limit orders entirely, creating gaps across venues. Latency differentials and asymmetric connectivity amplify these effects: faster participants can exploit stale quotes on slower venues, prompting slower liquidity providers to tighten quotes or exit. This is especially pronounced in small-cap and emerging-market securities where depth is already limited.
Another exacerbating feature is market-maker inventory constraints. When geopolitical shocks increase volatility, dealers face larger inventory risk and either widen quotes or reduce posted size, fragmenting liquidity as execution probability becomes venue-dependent. Platform-specific microrules such as minimum tick sizes, maker-taker fees, and differing auction mechanisms can further bias order routing, channeling volume to preferred venues and leaving others illiquid. Research summarized by Larry Harris at the University of Southern California highlights how such rule-driven incentives reallocate liquidity across fragmented systems.
Consequences and contextual nuances
Consequences include higher transaction costs, reduced immediacy, and impaired price discovery as trade flow and quotes become uneven across venues. Cross-venue latency and regulatory heterogeneity introduce territorial and cultural nuances: jurisdictions with tighter pre-trade transparency rules may see different migration patterns than dark-pool–friendly markets, and local risk-aversion norms affect whether dealers withdraw or absorb flow. Environmental factors such as overlapping trading hours and infrastructure resilience also matter; markets sharing time zones can propagate shocks faster, increasing simultaneous fragmentation.
In sum, microstructural features that increase uncertainty for liquidity providers—information asymmetry, shallow depth, high cancellation rates, latency asymmetries, inventory limits, and divergent venue rules—intensify fragmentation during geopolitical shocks. Empirical and theoretical work by Maureen O'Hara Cornell, Joel Hasbrouck New York University Stern, and Larry Harris University of Southern California supports these mechanisms and their practical consequences.