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Why Do Large Orders Receive Discounts On The London Stock Exchange?

Working Paper No. 99-0114

Posted: 23 Sep 1999  

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Vladimir Dvoracek

University College of the Fraser Valley

Eric N. Hughson

Claremont McKenna College - Robert Day School of Economics and Finance

Ingrid M. Werner

The Ohio State University - Fisher College of Business

Date Written: June 1999

Abstract

On the NYSE and exchanges that feature open limit order books, larger orders receive worse prices. Accordingly, market microstructure theory has focused on developing consistent models. However, on exchanges such as the London Stock Exchange, NASDAQ and FX markets, larger orders receive better prices on average. In this paper, we argue that differences in market design can explain this finding. On the LSE and NASDAQ, in sharp contrast to the NYSE or exchanges that feature open limit order books, competition between dealers is largely intertemporal: a trader identifies a particular dealer and negotiates a final price with only the intertemporal threat to switch dealers imposing pricing discipline on the dealer. We show that dealers will offer greater price improvement to more regular customers, and, in turn, these customers optimally choose to submit larger orders.

Hence empirically, we predict that there should be a striking difference between the relationship between price impact and trade size on exchanges where all orders are immediately exposed to price competition, such as the NYSE, where price impact and trade size should be positively correlated, and exchanges where competition is largely intertemporal, such as London, where price impact and trade size should be negatively correlated. We derive the implications for inter-dealer trade, dealer profits, and find testable restrictions for pricing across different traders and order sizes. We test the predictions using data from the LSE. The results offer strong support for our hypothesis that on the LSE, broker-dealer relationships drive pricing.

JEL Classification: G12

Suggested Citation

Bernhardt, Dan and Dvoracek, Vladimir and Hughson, Eric N. and Werner, Ingrid M., Why Do Large Orders Receive Discounts On The London Stock Exchange? (June 1999). Working Paper No. 99-0114. Available at SSRN: https://ssrn.com/abstract=179635

Dan Bernhardt (Contact Author)

University of Illinois at Urbana-Champaign - Department of Economics ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-5708 (Phone)

Vladimir Dvoracek

University College of the Fraser Valley ( email )

33844 King Road
Department of Economics
Abbotsford, British Columbia V2S 7M8
CANADA

Eric N. Hughson

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
909-607-3664 (Phone)

Ingrid M. Werner

The Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-6460 (Phone)
614-292-2418 (Fax)

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