Are the Stock Markets 'Rigged'? An Empirical Analysis of Regulatory Change

29 Pages Posted: 10 Mar 2018 Last revised: 28 Apr 2018

See all articles by Stephen F. Diamond

Stephen F. Diamond

Santa Clara University - School of Law

Jennifer W. Kuan

Tulane University - A.B. Freeman School of Business

Date Written: December 21, 2017

Abstract

Volatile events in the stock market such as the 2010 Flash Crash have sparked concern that financial markets are "rigged" in favor of trading firms that use high frequency trading ("HFT") systems. We analyze a regulatory change implemented by the SEC in 2007 by examining its effect on a key market metric, the bid-ask spread, an investor cost, and find that the regulatory shift, indeed, disadvantages investors. We link the implementation of this change to a shift in the volume of trades from a low-cost venue to a high-cost venue. We argue that this outcome is predicted by the incentives of the venues, non-profit stock exchanges owned by different types of members. The less-volatile, lower-cost New York Stock Exchange was owned by underwriters and included a specialist system that is less vulnerable to HFT tactics that can disadvantage investors.

Keywords: Stock Market, High Frequency Trading, Flash Crashes, Non-Profit, SEC

JEL Classification: D02, D40, K22, L1, L30, L50

Suggested Citation

Diamond, Stephen F. and Kuan, Jennifer W., Are the Stock Markets 'Rigged'? An Empirical Analysis of Regulatory Change (December 21, 2017). International Review of Law and Economics, Forthcoming; Santa Clara Univ. Legal Studies Research Paper No. 2018-07. Available at SSRN: https://ssrn.com/abstract=3137199

Stephen F. Diamond (Contact Author)

Santa Clara University - School of Law ( email )

500 El Camino Real
Santa Clara, CA 95053
United States

Jennifer W. Kuan

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

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