Trading Frictions and Market Structure: An Empirical Analysis

Journal of Business Finance & Accounting, Vol. 35, No. 3-4, pp. 563-579, 2008

28 Pages Posted: 6 Oct 2010

See all articles by Charlie X. Cai

Charlie X. Cai

University of Liverpool Management School

David Hillier

University of Strathclyde - Department of Accounting and Finance

Robert Hudson

Hull University Business School (HUBS)

Kevin Keasey

University of Leeds - Division of Accounting and Finance

Date Written: August 7, 2007

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.

Keywords: SETS, SEAQ, Trading Friction, Market Structure

JEL Classification: G12, G14, D23, L22

Suggested Citation

Cai, Charlie Xiaowu and Hillier, David and Hudson, Robert and Keasey, Kevin, Trading Frictions and Market Structure: An Empirical Analysis (August 7, 2007). Journal of Business Finance & Accounting, Vol. 35, No. 3-4, pp. 563-579, 2008. Available at SSRN: https://ssrn.com/abstract=1687011

Charlie Xiaowu Cai (Contact Author)

University of Liverpool Management School ( email )

University of Liverpool
Liverpool, L69 7ZA
United Kingdom

David Hillier

University of Strathclyde - Department of Accounting and Finance ( email )

Curran Building
100 Cathedral Street
Glasgow G4 0LN
United Kingdom
44 0141 330 4809 (Phone)
44 0141 330 4442 (Fax)

Robert Hudson

Hull University Business School (HUBS) ( email )

Hull, HU6 7RX
United Kingdom

Kevin Keasey

University of Leeds - Division of Accounting and Finance ( email )

Leeds LS2 9JT
United Kingdom
+44 (0)113 343 2618 (Phone)

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