They are especially grateful for the thoughtful and thorough comments of the anonymous referees and Martin Walker, the editor of JBFA. All errors are the authors' own.
Trading Frictions and Market Structure: An Empirical Analysis
Article first published online: 4 MAR 2008
© 2008 The Authors Journal compilation © 2008 Blackwell Publishing Ltd
Journal of Business Finance & Accounting
Volume 35, Issue 3-4, pages 563–579, April/May 2008
How to Cite
Cai, . C. X., Hillier, D., Hudson, R. and Keasey, K. (2008), Trading Frictions and Market Structure: An Empirical Analysis. Journal of Business Finance & Accounting, 35: 563–579. doi: 10.1111/j.1468-5957.2008.02076.x
- Issue published online: 4 MAR 2008
- Article first published online: 4 MAR 2008
- (Paper received January 2006, revised version accepted September 2007)
- trading friction;
- market structure
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.