The Value of Intermediation in the Stock Market

51 Pages Posted: 2 Aug 2019 Last revised: 13 Apr 2020

See all articles by Marco Di Maggio

Marco Di Maggio

Harvard Business School; National Bureau of Economic Research (NBER)

Mark Egan

Harvard University - Business School (HBS); National Bureau of Economic Research (NBER)

Francesco A. Franzoni

USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: April 10, 2020

Abstract

Brokers play a critical role in intermediating institutional transactions in the stock market. Despite the importance of brokers, we have limited information on what drives investors’ choices among them. We develop and estimate an empirical model of broker choice that allows us to quantitatively examine each investor’s responsiveness to execution costs, access to research, and order flow information. Studying over 300 million institutional trades, we find that investor demand is relatively inelastic with respect to trading commissions and that investors are willing to pay a premium for access to formal (top research analysts) and informal (order-flow information) research. There is also substantial heterogeneity across investors. Relative to other investors, hedge funds tend to be more price insensitive, place less value on sell-side research, and place more value on order-flow information. Using trader-level data, we find that investors are more likely to execute trades through intermediaries who are located physically closer and are less likely to trade with those that have engaged in misconduct in the past. Lastly, we use our empirical model to investigate soft-dollar arrangements and the unbundling of equity research and execution services related to the MiFID II regulations. We find that the bundling of execution and research potentially allows hedge funds and mutual funds to under-report management fees by 10%.

Keywords: Financial Intermediation, Institutional Investors, Research Analysts, Broker Networks, Equity Trading

JEL Classification: L11, G14, G23, G24

Suggested Citation

Di Maggio, Marco and Egan, Mark and Franzoni, Francesco A., The Value of Intermediation in the Stock Market (April 10, 2020). Available at SSRN: https://ssrn.com/abstract=3430405 or http://dx.doi.org/10.2139/ssrn.3430405

Marco Di Maggio

Harvard Business School ( email )

Soldiers Field
Baker Library 265
Boston, MA 02163
United States

HOME PAGE: http://https://www.hbs.edu/faculty/Pages/profile.aspx?facId=697248

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mark Egan (Contact Author)

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Baker Library 365
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Francesco A. Franzoni

USI Lugano ( email )

Via G. Buffi 13
Lugano, 6904
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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