Transaction fees: Impact on institutional order types, commissions, and execution quality

Abstract

Market participants and regulators are debating maker-taker pricing and whether fees split between limit and market orders impact routing and execution quality. Contrary to existing theory, my model predicts this split impacts gains from trade. When rebates increase, liquidity suppliers post more aggressive quotes. Given limit order fill rates, gains from trade fall as commissions increase with fees. Should institutional investors choose market orders with greater probability, fill rates increase and adverse selection decreases. As rebates are realized more frequently, commissions fall, increasing gains from trade in size and frequency. Empirical patterns in SEC Rule 605 confirm my testable predictions.

Keywords: Limit Order Book, Make-Take Fees, Broker-Dealers, Exchange Competition, Two-sided Markets

JEL Classification: G10, G12, G14, G18, G20, D40, D47