Hostname: page-component-586b7cd67f-t7fkt Total loading time: 0 Render date: 2024-11-23T21:10:42.522Z Has data issue: false hasContentIssue false
  • English
  • Français

Trade Execution Costs and Market Quality after Decimalization

Published online by Cambridge University Press:  06 April 2009

Hendrik Bessembinder
Hendrik Bessembinder
Affiliation:
[email protected], David Eccles School of Business, 1645 E. Campus Center Drive, University of Utah, Salt Lake City, UT 84112.
Get access Rights & Permissions [Opens in a new window]

Abstract

This study assesses trade execution costs and market quality for NYSE and Nasdaq stocks before and after the 2001 change to decimal pricing. Several theoretical predictions are confirmed. Quoted bid-ask spreads declined substantially on each market, with the largest declines for heavily traded stocks. The percentage of shares receiving price improvement increased on the NYSE, but not on Nasdaq. However, those trades completed at prices within or outside the quotes were improved or disimproved by smaller amounts after decimalization, and trades completed outside the quotes saw the largest reductions in trade execution costs, as a class. Effective bid-ask spreads as a percentage of share price, arguably the most relevant measure of execution costs for smaller trades, averaged 0.33% on a volume-weighted basis after decimalization for both NYSE and Nasdaq stocks. There is no evidence of systematic intraday reversals of quote changes on either market, as would be expected if decimalization had damaged liquidity supply.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 4 , December 2003 , pp. 747 - 777
Copyright
Copyright © School of Business Administration, University of Washington 2003

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Bacidore, J.; Battalio, R.; and Jennings, R. “Order Submission Strategies, Liquidity Supply, and Trading in Pennies on the New York Stock Exchange.” Working Paper, Indiana Univ. (2001a).Google Scholar
Bacidore, J.; Battalio, R.; and Jennings, R. “Changes in Order Characteristics, Displayed Liquidity, and Execution Quality on the New York Stock Exchange around the Switch to Decimal Pricing.” New York Stock Exchange Working Paper 2001–02 (2001b).Google Scholar
Bessembinder, H. “Trade Execution Costs on Nasdaq and the NYSE: A Post Reform Comparison.” Journal of Financial and Quantitative Analysis, 34 (1999), 387–407.CrossRefGoogle Scholar
Bessembinder, H. “Issues in Assessing Trade Execution Costs.” Journal of Financial Markets, 6 (2003), 233–257.CrossRefGoogle Scholar
Bessembinder, H., and Kaufman, H. “A Comparison of Trade Execution Costs for NYSE and Nasdaq Listed Stocks.” Journal of Financial and Quantitative Analysis, 32 (1997), 287–310.CrossRefGoogle Scholar
Chapman, P. “Nasdaq Market Makers Rescue Plan: When is a Commission Not a Commission?” Traders Magazine (08 1, 2001).Google Scholar
Chakravarty, S.; Harris, S.; and Wood, R. “Decimal Trading and Market Impact.” Working Paper, Univ. of Memphis (2001a).CrossRefGoogle Scholar
Chakravarty, S.; Harris, S.; and Wood, R. “Decimal Trading and Market Impact: The Nasdaq Experience.” Working Paper, Univ. of Memphis (2001b).CrossRefGoogle Scholar
Chung, K., and Chuwonganant, C. “Tick Size and Quote Revisions on the NYSE.” Journal of Financial Markets, 5 (2002), 391–410.CrossRefGoogle Scholar
Chung, K.; Ness, B. Van; and Ness, R. Van “Spreads, Depths, and Quote Clustering on the NYSE and Nasdaq: Evidence from the 1997 SEC Rule Changes.” Working Paper, Univ. of Memphis (2000).Google Scholar
Chung, K.; Ness, B. Van; and Ness, R. Van “Are Nasdaq Stocks More Costly to Trade than NYSE Stocks? Evidence after Decimalization.” Working Paper, Kansas State Univ. (2001).CrossRefGoogle Scholar
Edwards, A. “Are the Best Quotes Good Indications of the Supply of Liquidity? Evidence from Decimalization.” Working Paper, United States Securities and Exchange Commission (2001).Google Scholar
Ellis, K.; Michaely, R.; and O'Hara, M.. “The Accuracy of Trade Classification Rules: Evidence from Nasdaq.” Journal of Financial and Quantitative Analysis, 35 (2000), 529–551.CrossRefGoogle Scholar
Goldstein, M., and Kavajecz, K. “Eighths, Sixteenths and Market Depth: Changes in Tick Size and Liquidity Provision on the NYSE.” Journal of Financial Economics, 56 (2000), 125–149.CrossRefGoogle Scholar
Harris, L. “Minimum Price Variations, Discrete Bid-Ask Spreads, and Quotation Sizes.” Review of Financial Studies, 7 (1994), 149–178.CrossRefGoogle Scholar
Harris, L. “Decimalization: A Review of the Arguments and Evidence.” Working Paper, Univ. of Southern California (1997).Google Scholar
Harris, L. “Trading in Pennies: A Survey of the Issues' Decimalization: A Review of the Arguments and Evidence.” Working Paper, Univ. of Southern California (1999).Google Scholar
Huang, R., and Stoll, H. “Dealer versus Auction Markets: A Paired Comparison of Execution Costs on Nasdaq and the NYSE.” Journal of Financial Economics, 41 (1996), 313–358.CrossRefGoogle Scholar
Jennings, R. “Getting ‘Pennied’: The Effect of Decimalization on Traders' Willingness to Lean on the Limit Order Book at the New York Stock Exchange.” Working Paper 2001–2001, NYSE.Google Scholar
Jones, C., and Lipson, M. “Sixteenths: Direct Evidence on Institutional Trading Costs.” Journal of Financial Economics, 59 (2001), 253–278.CrossRefGoogle Scholar
LaPlante, M., and Muscarella, C. “Do Institutions Receive Comparable Executions in the NYSE and Nasdaq Markets? A Transactions Study of Block Trades.” Journal of Financial Economics, 45 (1997), 97–134.CrossRefGoogle Scholar
Lee, C., and Ready, M.Inferring Trade Direction from Intra-day Data.” Journal of Finance, 46 (1991), 733–746.CrossRefGoogle Scholar
Lesmond, D.; Schill, M.; and Zhou, C. “The Illusory Nature of Momentum Profits.” Working Paper, Univ. of Virginia (2001).Google Scholar
Nasdaq Stock Market, Inc. “Impact of Decimalization.” Press Release, Nasdaq Economic Research, 06 12, 2001 (2001a).Google Scholar
Nasdaq Stock Market, Inc. “The Impact of Decimalization on the Nasdaq Stock Market: Final Report to the SEC.” Manuscript, Nasdaq Economic Research, 06 11, 2001 (2001b).Google Scholar
New York Stock Exchange. “Comparing Bid-Ask Spreads on the New York Stock Exchange and Nasdaq Immediately following Nasdaq Decimalization.” Manuscript, NYSE Research, 07 26, 2001 (2001a).Google Scholar
New York Stock Exchange. “Decimalization of Trading on the New York Stock Exchange: A Report to the Securities and Exchange Commission.” Manuscript, NYSE Research, 09 7, 2001 (2001b).Google Scholar
Peterson, T., and Sirri, E. “Evaluation of the Biases in Execution Cost Estimation Using Trade and Quote Data.” Journal of Financial Markets, 6 (2003), 259–280.CrossRefGoogle Scholar
Poterba, J., and Summers, L. “Mean Reversion in Stock Prices: Evidence and Implications.” Journal of Financial Economics, 22 (1988), 27–60.CrossRefGoogle Scholar
Ready, M. “The Specialist's Discretion: Stopped Orders and Price Improvement.” Review of Financial Studies, 12 (1999), 1075–1112.CrossRefGoogle Scholar
Roll, R. “A Simple Measure of the Effective Bid-Ask Spread in an Efficient Market.” Journal of Finance, 39 (1984), 1127–1139.Google Scholar
Schultz, P. “Regulatory and Legal Pressures and the Costs of Nasdaq Trading.” Review of Financial Studies, 13 (2000), 917–957.CrossRefGoogle Scholar
Securities and Exchange Commission. “Report on the Comparison of Order Executions across Equity Market Structures.” Office of Economic Analysis, Washington, DC (2001).Google Scholar
Seppi, D. “Liquidity Provision with Limit Orders and a Strategic Specialist.” Review of Financial Studies, 10 (1997), 103–150.CrossRefGoogle Scholar
Smith, J.; Selway, J.; and McCormick, T. “The Nasdaq Stock Market: Historical Background and Current Operation.” NASD Working Paper 98–01, National Association of Securities Dealers, Washington, DC (1998).Google Scholar
Stoll, H. “Friction.” The Journal of Finance, 55 (2000), 1479–1514.CrossRefGoogle Scholar
Weston, J. “Competition on the Nasdaq and the Impact of Recent Market Reforms.” Journal of Finance, 55 (2000), 2565–2598.CrossRefGoogle Scholar