Trading Volume Shares and Market Quality in a Zero Commission World

Abstract

We study the impact of the adoption of zero commissions by major retail brokers and find that retail brokers that started charging zero commissions dramatically increase their market share of client assets. In addition, these retail brokers increasingly routed orders off exchange (i.e., OTC) to wholesale market makers instead of exchanges. Market quality improves overall. Retail brokerages no longer earn commissions and so their new economic strategy may be to sell retail order flow to wholesaler market makers and receive payment for order flow. Another important implication of zero commissions is for traders to switch to smaller order size buckets. More orders receive price improvement but its magnitude per share is smaller. In addition, effective spreads decline because retail investors that use non-marketable limit orders, are no longer constrained by commission costs and place many more small orders across the pricing grid including inside the bid-ask spread. Therefore, the prices at which liquidity-supplying orders are quoted are no longer constrained by non-zero commissions. Realized spreads, however, are unchanged suggesting that retail investors submitting liquidity-demanding orders are uninformed.

Keywords: Zero Commission, Microstructure, Brokerage Competition, Retail Trading

JEL Classification: D4, G12, G14, L11