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Trading Frictions and Market Structure: An Empirical Analysis
Author(s) -
Cai Charlie X.,
Hillier David,
Hudson Robert,
Keasey Kevin
Publication year - 2008
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/j.1468-5957.2008.02076.x
Subject(s) - immediacy , equity (law) , order (exchange) , transaction cost , adverse selection , economics , database transaction , financial economics , business , value (mathematics) , monetary economics , microeconomics , finance , philosophy , programming language , epistemology , machine learning , political science , computer science , law
Abstract: Market structure affects the informational and real frictions faced by traders in equity markets. Using bid‐ask spreads, we present evidence which suggests that while real frictions associated with the costs of supplying immediacy are less in order‐driven systems, informational frictions resulting from increased adverse selection risk are considerably higher in these markets. Firm value, transaction size and order location are all major determinants of the trading costs borne by investors. Consistent with the stealth trading hypothesis of Barclay and Warner (1993), we report that informational frictions are at their highest for medium size trades that go through the order book. Finally, while there is no doubt that the total costs of trading on order‐driven systems are lower for very liquid securities, the inherent informational inefficiencies of the trading format should not be ignored. This is particularly true for the vast majority of small to mid‐size stocks that experience infrequent trading and low transaction volume.