Intraday Variation in the Bid-Ask Spread: Evidence after the Market Reform

In this article we show that intraday variation in spreads for Nasdaq‐listed stocks has converged to intraday variation in spreads for NYSE‐listed stocks after the implementation of the new order‐handling rules. We attribute this convergence to the Limit Order Display Rule, which requires that limit orders be displayed in Nasdaq best bid and offer when they are better than quotes posted by market makers. Our findings suggest that the different patterns of intraday spreads between NYSE and Nasdaq stocks reported in prior studies can largely be attributed to the different treatment of limit orders between the NYSE and Nasdaq before the market reform.     

The Impact of the Reduction in Tick Increments in Major U.S. Markets on Spreads,Depth, and Volatility

This study presents an analysis of the impact of the introduction of quotes in sixteenths of a dollar on the AMEX, Nasdaq, and NYSE in mid-1997 on select market characteristics such as spreads, effective spreads, quoted depth, and volume. The findings of the study document reductions in the bid-ask spread, effective spread, and a statistically significant increase in the number of quotes. Interestingly, we find that liquidity, as measured by the total depth at the bid and ask, declines significantly on the AMEX and NYSE, but increases on the Nasdaq. Trading volume increases on the NYSE, but remains unchanged for the AMEX and Nasdaq. We also find that the proportion of even-increment quotes is a relevant factor affecting percentage spreads for Nasdaq both before and after and for the NYSE only after the change in quoting increments.     

Transactions Costs and Holding Periods for Common Stocks

Amihud and Mendelson (1986) and Constantinides (1986) provide a theoretical basis for the proposition that assets with higher transactions costs are held by investors for longer holding periods, and vice versa. We examine average holding periods and bid-ask spreads for Nasdaq stocks from 1983 through 1991 and for New York Stock Exchange (NYSE) stocks from 1975 through 1989 and find strong evidence that, as predicted, the length of investors' holding periods is related to bid-ask spreads. We also find that the relation between holding periods and bid-ask spreads is much stronger on Nasdaq, where spreads are larger, than on the NYSE, where spreads are smaller.     

Bid-Ask Spreads,Information Asymmetry,and Abnormal Investor Sentiment: Evidence from Closed-End Funds

Using a sample of closed-end equity funds listed on the NYSE from 1994 to 1999, we investigate differences in spreads and adverse selection costs between the closed-end funds and a matched sample of common stocks. We find that spreads and adverse selection costs for the closed-end funds are significantly lower than those of control stocks. The results are consistent for the subperiods both before and after the minimum tick size change on NYSE on June 24, 1997. The differences of spreads and adverse selection costs cannot be attributed to the differences in the characteristics of the closed-end funds and the matched sample of common stocks. Lastly, we find that abnormal investor sentiment and adverse selection costs of closed-end funds are positively correlated over time.     

Market-Making in the Third Market for NYSE-Listed Securities

This paper empirically examines market making in the third market for common stocks that are listed on the NYSE. Although the same non-NYSE members make a market on both types of stocks, bid-ask spreads are wider on Rule 19c-3 stocks than on Rule 390 stocks. Market-making by NYSE members is minimal and spreads posted by NYSE members are wider than those posted on identical stocks by non-NYSE members. This suggests that NYSE members do not compete on the basis of spread but use methods such as price matching and the internalization of orders to attract order flow to the third market.     

Cost of Transacting and Expected Returns in the Nasdaq Market

This article empirically examines the liquidity premium predicted by the Amihud and Mendelson (1986) model using Nasdaq data over the 1973–1990 period. The results support the model and are much stronger than for the New York Stock Exchange (NYSE), as reported by Chen and Kan (1989) and Eleswarapu and Reinganum (1993) . I conjecture that the stronger evidence on the Nasdaq is due to the dealers' inside spreads on the Nasdaq being a better proxy for the actual cost of transacting than the quoted spreads on the NYSE, since the Nasdaq dealers do not face competition from limit orders or floor traders.     

What Explains the Bid‐Ask Spread Decline after Nasdaq Reforms?

This paper examines whether the decrease in bid‐ask spreads on Nasdaq after the 1997 reforms is due to a decrease in market‐making costs and/or an increase in market competition for order flows. Unlike previous studies, we jointly examine how competition and trading costs affect bid‐ask spreads. In addition, we separate the effects of informed trading and liquidity costs on bid‐ask spreads. Informed trading cost is directly estimated for each Nasdaq stock using a Bayesian theoretic model. Empirical results show that market‐making costs and competition significantly affect bid‐ask spreads. The post‐reform decrease in bid‐ask spreads is largely due to both an increase in competition and a decrease in informed trading and liquidity costs on Nasdaq.     

The Post-Reform Bid-Ask Spread Disparity between Nasdaq and the NYSE

We report further evidence of the difference in execution costs between Nasdaq and the NYSE before and after the 1997 market reforms. We find that informed trading costs are consistently higher on Nasdaq both before and after the reforms. In the pre‐reform period the Nasdaq‐NYSE disparity in bid‐ask spreads cannot be completely attributed to the difference in informed trading costs. However, in the post‐reform period the spread difference between these two markets becomes insignificant with the effect of informed trading costs controlled. Our findings are consistent with the contention that the reforms have largely reduced noninformation trading costs and dealers' rents.     

Liquidity in auction and specialist market structures: Evidence from the Italian bourse

Several studies find that bid-ask spreads for stocks listed on the NYSE are lower than for stocks listed on NASDAQ. While this suggests that specialist market structures provide greater liquidity than competing dealer markets, the nature of trading on the NYSE, which comprises a specialist competing with limit order flow, obfuscates the comparison. In 2001, a structural change was implemented on the Italian Bourse. Many stocks that traded in an auction market switched to a specialist market, where the specialist controls order flow. Results confirm that liquidity is significantly improved when stocks commence trading in the specialist market. Analysis of the components of the bid-ask spread reveal that the adverse selection component of the spread is significantly reduced. This evidence suggests that specialist market structures provide greater liquidity to market participants.     

Is the Adverse Selection Component Really Higher on the NYSE/Amex than on the Nasdaq?

Affleck–Graves, Hegde and Miller (1994) find that the adverse selection component of the bid–ask spread is higher for NYSE and Amex stocks than for Nasdaq stocks. Using the model of Huang and Stoll (1997), we revisit their study and find the opposite to be true – the adverse selection component is actually higher for Nasdaq stocks than for NYSE and Amex stocks. The economic magnitude of this additional adverse selection cost is very significant. Our results have important implications for the understanding of information production in dealer versus auction markets, and the costs of trading on such markets.     

The competitive effects of US decimalization: Evidence from the US-listed Canadian stocks

This paper analyzes the impact of US decimalization on the Canadian stocks listed on the Toronto Stock Exchange (TSE) and either the New York Stock Exchange (NYSE) or National Association of Securities Dealers Automated Quotation System (Nasdaq) in the US. Using a sample of 126 firms, we find that the US trading of these stocks increases after decimalization, but this increase is not at the expense of TSE volume. Indeed, the TSE volume increases substantially for those securities that are traded on Nasdaq and increases marginally for those securities that are traded on the NYSE. Most of the increase in volume is in retail-sized trades. The bid–ask spreads and the quote depths decline on all exchanges, but by a greater amount in the US than in Canada. The depths on the NYSE decline from being above the TSE depths to well below the TSE depths. We also find that the decline in the TSE spread is directly related to the size of the firm and to the decline in the US spread, and is inversely related to the pre-decimalization ratio of spreads on the US exchange and the TSE. Overall, our results indicate that the US decimalization had the desired positive impact on trading in both the US and Canada, with a decrease in spreads and an increase in retail-sized trading.     

The flash crash: An examination of shareholder wealth and market quality

We investigate stock returns, market quality, and options market activity around the flash crash of May 6, 2010. Abnormal returns are negative on the day of and the day after the flash crash for stocks that had trades that executed during the crash subsequently cancelled by either Nasdaq or NYSE Arca. Consistent with studies that suggest that other sources of liquidity withdrew from the markets during the flash crash, we find that the fraction of trades executed by the NYSE increases during this volatile period. Market quality deteriorates following the flash crash as bid-ask spreads increase and quote depths decrease. Evidence from the options markets indicates that investor uncertainty increased around the time of the crash and remained elevated for several days.     

Does Idiosyncratic Risk Really Matter?

Goyal and Santa‐Clara (2003) find a significantly positive relation between the equal‐weighted average stock volatility and the value‐weighted portfolio returns on the NYSE/AMEX/Nasdaq stocks for the period of 1963:08 to 1999:12. We show that this result is driven by small stocks traded on the Nasdaq, and is in part due to a liquidity premium. In addition, their result does not hold for the extended sample of 1963:08 to 2001:12 and for the NYSE/AMEX and NYSE stocks. More importantly, we find no evidence of a significant link between the value‐weighted portfolio returns and the median and value‐weighted average stock volatility.     

Electronic Communication Networks and Liquidity on the Nasdaq

This paper examines the growth of electronic communication networks (ECNs) and their impact on the liquidity of Nasdaq stocks. I find that the recent growth of trading through ECNs has resulted in tighter bid-ask spreads, greater depths, and less concentrated markets. Overall, our results support the hypothesis that electronic communication networks have improved Nasdaq liquidity.     

Competition on the Nasdaq and the Impact of Recent Market Reforms

This paper examines the effect of recent market reforms on the competitive structure of the Nasdaq. Our results show that changes in inventory and information costs cannot explain the post-reform decrease in bid-ask spreads. We interpret this as evidence that the reforms have reduced Nasdaq dealers' rents. Additionally, we find that the difference between NYSE and Nasdaq spreads have been greatly diminished with the new rules. Further, the reforms have resulted in an exit, ceteris paribus , from the industry for market making. Overall, our results provide strong evidence that the reforms have improved competition on the Nasdaq.     

Stock Splits, Tick Size, and Sponsorship

A traditional explanation for stock splits is that they increase the number of small shareholders who own the stock. A possible reason for the increase is that the minimum bid-ask spread is wider after a split and brokers have more incentive to promote a stock. I document a large number of small buy orders following Nasdaq and NYSE/AMEX splits during 1993 to 1994. I also find strong evidence that trading costs increase, and weak evidence that costs of market making decline following splits. This is consistent with splits acting as an incentive to brokers to promote stocks.     

Investor Recognition, Liquidity, and Exchange Listings in the Reformed Markets

We examine multiple facets of firms' descisions to list on the NYSE. Although the average Nasdaq spreads are now comparable to the average NYSE spreads, we find that firms continue to switch from Nasdaq to the NYSE, and that they experience positive cumulative abnormal returns on listing. Using a simultaneous ststem of equations approach, we establish that enhanced investor recognition mainly explains this phenomenon. A logistic regression suggesrts that corporate listing choice is consistent with these findings, since eligible unlisted firms already have high volumes and recognition and might not benefit as much as do firms that actually switch.     

Institutional Equity Trading Costs: NYSE Versus Nasdaq

We compare execution costs (market impact plus commission) on the New York Stock Exchange (NYSE) and Nasdaq for institutional investors. The differences in cost generally conform to each market's area of specialization. Controlling for firm size, trade size, and the money management firm's identity, costs are lower on Nasdaq for trades in comparatively smaller firms, while costs for trading the larger stocks are lower on NYSE. The cost differences estimated from a regression model are, however, sensitive to the choice of time period.     

UNLISTED TRADING PRIVILEGES,LIQUIDITY, AND STOCK RETURNS

In this study we examine the effect of dual trading through unlisted trading privileges (UTPs) on liquidity and stock returns. Stocks with UTPs trade in a different market structure than stocks listed and traded only on the AMEX and NYSE. Differences in market structure may affect stock returns through liquidity services provided by the competing markets. The sample comprises 852 AMEX and NYSE firms that began unlisted trading on the Philadelphia, Pacific, Midwest, or Cincinnati exchanges between 1984 and 1988. The results show significantly positive abnormal returns around the SEC's announcement of a regional exchange's filing for UTPs. The results also suggest that increased competition improves trading liquidity. Only stocks with low liquidity before UTPs announcements experience significantly improved liquidity and positive stock returns.     

Dimensions of execution quality: Recent evidence for US equity markets

I analyze market-order execution quality using order-based data reported in accordance with Securities and Exchange Commission Rule 11Ac1-5. These data facilitate a comprehensive investigation of multiple dimensions of execution quality, including measures of costs and speed, for large samples of common stocks on Nasdaq and the NYSE. The evidence is consistent with competitive equity markets. Overall execution costs on Nasdaq exceed those on the NYSE, but orders execute faster. This relationship reverses for larger orders exceeding 1,999 shares. The apparent trade-off between costs and speed suggests that inferring execution quality from costs alone could be problematical. It also illustrates the need for models of trader behavior that can accommodate multiple dimensions of execution quality.