Why Allow Internalization?

Over the last decade, an increasing portion of U.S. equity trading volume has been executed away from public exchanges. A common form of this off-exchange trading is internalization, a practice whereby a brokerage fills a client's order from its own inventory. I develop a model to study the impact of internalization on traders’ behavior and market outcomes. In equilibrium, trades in the limit order book, relative to internalized orders, stem …