Why Effective Spreads on NASDAQ Were Higher than on the New York Stock Exchange in the 1990s

University of Memphis Working Paper

34 Pages Posted: 20 Oct 2003

See all articles by Robert Wood

Robert Wood

University of Memphis - Fogelman College of Business and Economics

George J. Benston

Emory University - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: August 13, 2003

Abstract

Two hypotheses have been advanced to explain why spreads on Nasdaq were substantially higher than those on the NYSE in the 1990s - "collusion" and "preferencing and payment for order flow." We present data on all actively traded stocks of relative effective spreads (RES) on these markets, aggregated monthly over 1987-1999 and advance a third hypothesis: Nasdaq "SOES-day-trading." We estimate Nasdaq and NYSE informed-trade losses and gains to market makers on six trade sizes, and find that losses on trades we ascribe to SOES day traders were substantially greater than those on other trades, offset somewhat by gains to small-trade-size investors. Nasdaq market makers' response resulted in greater RES and increased trading within the best quotes, predominantly on larger trade sizes. Among market makers' customers, the costs of SOES day trading were borne largely by traders of the smaller trade sizes. The data are consistent with the "SOES-day-trading" hypotheses, but not with the other two. Furthermore, the mandatory SOES "experiment" gave impetus to trading via ECNs, which now dominate Nasdaq.

Keywords: Microstructure, day trading, SOES, bid/ask spreads, Nasdaq vs. NYSE

JEL Classification: C12, C13, G10

Suggested Citation

Wood, Robert A. and Benston, George J., Why Effective Spreads on NASDAQ Were Higher than on the New York Stock Exchange in the 1990s (August 13, 2003). University of Memphis Working Paper, Available at SSRN: https://ssrn.com/abstract=436640 or http://dx.doi.org/10.2139/ssrn.436640

Robert A. Wood (Contact Author)

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States
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HOME PAGE: http://www.people.memphis.edu/~rwood/

George J. Benston

Emory University - Department of Accounting ( email )

Goizueta Business School
1300 Clifton Road
Atlanta, GA 30322
United States
404-727-7831 (Phone)
404-727-5238 (Fax)

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