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Trading Frictions and Market Structure: An Empirical Analysis

Author

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  • Charlie X. Cai
  • David Hillier
  • Robert Hudson
  • Kevin Keasey

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.

Suggested Citation

  • Charlie X. Cai & David Hillier & Robert Hudson & Kevin Keasey, 2008. "Trading Frictions and Market Structure: An Empirical Analysis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(3‐4), pages 563-579, April.
    • Handle: RePEc:bla:jbfnac:v:35:y:2008:i:3-4:p:563-579
    DOI: 10.1111/j.1468-5957.2008.02076.x
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    References listed on IDEAS

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    1. Joel Hasbrouck, 2003. "Intraday Price Formation in U.S. Equity Index Markets," Journal of Finance, American Finance Association, vol. 58(6), pages 2375-2400, December.
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    Cited by:

    1. Zhang, Qi & Cai, Charlie X. & Keasey, Kevin, 2013. "Market reaction to earnings news: A unified test of information risk and transaction costs," Journal of Accounting and Economics, Elsevier, vol. 56(2), pages 251-266.
    2. George F. Tannous & Ying Zhang, 2008. "Cross‐listing and Trading on the Domestic Market: Evidence from Canada–US Partial Holidays," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(9‐10), pages 1245-1275, November.
    3. Kaun Y. Lee & Kee H. Chung, 2009. "Information‐Based Trading and Price Improvement," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(5‐6), pages 754-773, June.

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