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Trading Fees and Efficiency in Limit Order Markets

Author

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  • Jean-Edouard Colliard
  • Thierry Foucault

Abstract

Competition among trading platforms has considerably reduced trading fees in stock markets. We show that this evolution is not necessarily beneficial to investors. Although they increase gains from trade when a trade happens, lower trading costs can induce investors to post limit orders with a smaller execution probability. In this case, gains from trade are realized less frequently and investors can be worse off. Our model has testable implications for the effects of trading fees and their breakdown between liquidity suppliers and liquidity demanders on limit order fill rates and bid-ask spreads. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Jean-Edouard Colliard & Thierry Foucault, 2012. "Trading Fees and Efficiency in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 25(11), pages 3389-3421.
  • Handle: RePEc:oup:rfinst:v:25:y:2012:i:11:p:3389-3421
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    File URL: http://hdl.handle.net/10.1093/rfs/hhs089
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    References listed on IDEAS

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    1. Cantillon, Estelle & Yin, Pai-Ling, 2011. "Competition between exchanges: A research agenda," International Journal of Industrial Organization, Elsevier, vol. 29(3), pages 329-336, May.
    2. Burton Hollifield & Robert A. Miller & Patrik Sandås & Joshua Slive, 2006. "Estimating the Gains from Trade in Limit-Order Markets," Journal of Finance, American Finance Association, vol. 61(6), pages 2753-2804, December.
    3. Gehrig, Thomas, 1993. "Intermediation in Search Markets," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 2(1), pages 97-120, Spring.
    4. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2013. "Liquidity Cycles and Make/Take Fees in Electronic Markets," Journal of Finance, American Finance Association, vol. 68(1), pages 299-341, February.
    5. Cantillon, Estelle & Yin, Pai-Ling, 2008. "Competition between Exchanges: Lessons from the Battle of the Bund," CEPR Discussion Papers 6923, C.E.P.R. Discussion Papers.
    6. Thierry Foucault & Albert J. Menkveld, 2008. "Competition for Order Flow and Smart Order Routing Systems," Journal of Finance, American Finance Association, vol. 63(1), pages 119-158, February.
    7. Katya Malinova & Andreas Park, 2015. "Subsidizing Liquidity: The Impact of Make/Take Fees on Market Quality," Journal of Finance, American Finance Association, vol. 70(2), pages 509-536, April.
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    Citations

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    Cited by:

    1. Philip Vermeulen, 2012. "Bank dependence and investment during the financial crisis," Research Bulletin, European Central Bank, vol. 17, pages 12-14.
    2. Simone Manganelli, 2012. "The impact of the Securities Markets Programme," Research Bulletin, European Central Bank, vol. 17, pages 2-5.
    3. Thomas Johann & Erik Theissen, 2013. "Liquidity measures," Chapters,in: Handbook of Research Methods and Applications in Empirical Finance, chapter 10, pages 238-255 Edward Elgar Publishing.
    4. Degryse, H.A. & van Achter, M. & Wuyts, G., 2012. "Internalization, Clearing and Settlement, and Liquidity," Discussion Paper 2012-002, Tilburg University, Center for Economic Research.
    5. repec:spr:joecth:v:64:y:2017:i:2:d:10.1007_s00199-016-0989-9 is not listed on IDEAS
    6. Nathalie Oriol & Alexandra Rufini & Dominique Torre, 2015. "Should Dark Pools be Banned from Regulated Exchanges?," GREDEG Working Papers 2015-21, Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), University of Nice Sophia Antipolis.
    7. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 44621, University Library of Munich, Germany, revised Jan 2013.
    8. Comerton-Forde, Carole & Putniņš, Tālis J., 2015. "Dark trading and price discovery," Journal of Financial Economics, Elsevier, vol. 118(1), pages 70-92.
    9. Hoffmann, Peter, 2016. "Adverse selection, market access, and inter-market competition," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 108-119.
    10. Marios Panayides & Barbara Rindi & Ingrid M. Werner, 2017. "Trading Fees and Intermarket Competition," Working Papers 595, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    11. Hans Degryse & Frank de Jong & Vincent van Kervel, 2015. "The Impact of Dark Trading and Visible Fragmentation on Market Quality," Review of Finance, European Finance Association, vol. 19(4), pages 1587-1622.
    12. Bernd Schwaab, 2012. "Conditional probabilities and contagion measures for euro area sovereign default risk," Research Bulletin, European Central Bank, vol. 17, pages 6-11.
    13. Gomber, Peter & Sagade, Satchit & Theissen, Erik & Weber, Moritz Christian & Westheide, Christian, 2013. "Competition/fragmentation in equities markets: A literature survey," SAFE Working Paper Series 35, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    14. Sarah Draus, 2012. "Market Power on Exchanges: Linking Price Impact to Trading Fees," CSEF Working Papers 490, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    15. Vince Bourke & David Porter, 2015. "The Effects of Make and Take Fees in Experimental Markets," Working Papers 15-19, Chapman University, Economic Science Institute.
    16. Johannes A. Skjeltorp & Elvira Sojli & Wing Wah Tham, 2012. "Identifying cross-sided liquidity externalities," Working Paper 2012/20, Norges Bank.
    17. Bruno Biais & Thierry Foucault, 2014. "HFT and Market Quality," Bankers, Markets & Investors, ESKA Publishing, issue 128, pages 5-19, January-F.
    18. Hoffmann, Peter, 2013. "A dynamic limit order market with fast and slow traders," Working Paper Series 1526, European Central Bank.
    19. repec:uts:finphd:34 is not listed on IDEAS
    20. Markus Baldauf & Joshua Mollner, 2015. "Trading in Fragmented Markets," Discussion Papers 15-018, Stanford Institute for Economic Policy Research.
    21. Albert Menkveld & Boyan Jovanovic, 2016. "Dispersion and Skewness of Bid Prices," 2016 Meeting Papers 1395, Society for Economic Dynamics.
    22. Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2013. "High frequency trading and price discovery," Working Paper Series 1602, European Central Bank.
    23. Hoffmann, Peter, 2014. "A dynamic limit order market with fast and slow traders," Journal of Financial Economics, Elsevier, vol. 113(1), pages 156-169.
    24. David A. Cimon, 2016. "Broker Routing Decisions in Limit Order Markets," Staff Working Papers 16-50, Bank of Canada.
    25. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 39855, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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