Electronic Communication Networks, Market Makers, and the Components of the Bid-Ask Spread
40 Pages Posted: 27 Oct 2007 Last revised: 1 Sep 2014
Date Written: September 1, 2008
We investigate why trading costs through Electronic Communication Networks (ECNs) are lower than trading costs with market makers through estimating the components of the bid-ask spread. Additionally, we show how the composition and size of bid-ask spreads change with the market environment. We find the adverse selection cost component of the bid-ask spread to be lower when ECNs are alone at the inside compared to when market makers are alone at the inside. The magnitude or size of the inside spread is largest during periods of high volatility but smallest when stock returns approach zero.
Keywords: ECNs, Bid-Ask Spread, Market Microstructure, Alternative Trading Systems
JEL Classification: G10, G14
Suggested Citation: Suggested Citation