Why retail flow is cheap and institutional flow is toxic
Asked at Citadel Securities, Virtu
A wholesale market maker will pay brokers for retail order flow and then fill those orders at prices better than the public quote (price improvement). Yet the same firm quotes large institutional orders a wide spread, or declines them. Filling retail is profitable; filling institutions is dangerous.
Explain the mechanics. Why is retail flow worth paying for while institutional flow must be charged more?
Show a hint
The spread is compensation for adverse selection. Ask which kind of flow is more likely to be right about the next price move.
Your answer
This one is open-ended. Work it through, then check your reasoning against the full solution.