Do Investors Save When Market Makers Pay? Retail Execution Costs Under Payment for Order Flow Models

Abstract

We directly compare retail investor execution costs with exchange execution costs. We find off-exchange retail trades execute at lower effective spreads than comparable exchange trades, primarily due to the uninformed nature of retail trades. These results hold when payment for order flow (PFOF) became the main source of trading revenue for brokers, suggesting that these arrangements do not harm retail investors. Additionally, we find that current standards of retail execution quality overstate economic savings and suggest policy changes to represent these more accurately to investors.

Keywords: Zero Commission, Retail Trading, Execution Cost, Microstructure, Stock Trading

JEL Classification: D4, G12, G14, G24, L11