Measuring Institutional Trading Costs and the Implications for Finance Research: The Case of Tick Size Reductions

47 Pages Posted: 17 Oct 2018 Last revised: 1 Nov 2018

See all articles by Gregory W. Eaton

Gregory W. Eaton

Oklahoma State University - Stillwater - Department of Finance

Paul J. Irvine

Neeley School of Business

Tingting Liu

Iowa State University

Date Written: November 1, 2018

Abstract

The role of institutional investors has attracted significant attention in finance research. Relying on commonly used liquidity measures, numerous studies have investigated the impact of institutional trading costs on firm activities. In this paper, we demonstrate that many widely used liquidity measures do not adequately capture institutional trading costs. Using proprietary data on institutional trade orders, we construct a price impact measure that better represents the costs faced by institutional investors. We find that price impact is not correlated with many common liquidity proxies, most of which capture the cost of executing a small order immediately. In addition, institutional trading costs are not dramatically impacted by the implementation of decimalization in U.S. equity markets, casting doubt on the widely used identification strategy that employs decimalization to exploit an exogenous improvement in stock liquidity. Indeed, we find that conclusions from prior research are significantly altered when we measure liquidity using data on institutional trades. This result is particularly salient when institutions are proposed as the mechanism initiating changes in firm behavior.

Suggested Citation

Eaton, Gregory W. and Irvine, Paul J. and Liu, Tingting, Measuring Institutional Trading Costs and the Implications for Finance Research: The Case of Tick Size Reductions (November 1, 2018). Available at SSRN: https://ssrn.com/abstract=3255735 or http://dx.doi.org/10.2139/ssrn.3255735

Gregory W. Eaton (Contact Author)

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States

Paul J. Irvine

Neeley School of Business ( email )

Fort Worth, TX 76129
United States

Tingting Liu

Iowa State University ( email )

2330 Gerdin Business Building
Ames, IA 50011
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
52
Abstract Views
265
rank
379,262
PlumX Metrics