Transaction Costs and Price Volatility: Evidence from Commission Deregulation
Posted: 10 Oct 1998
Some researchers have recently suggested that lower transaction costs induce small (or noise) traders to trade more actively, thus increasing both the noise component and total volatility of asset prices. We empirically evaluate this conjecture by examining changes in volatility surrounding the abolition in 1975 of fixed brokerage fees on the NYSE. We use a control sample of NASDAQ issues that are unaffected by the abolition. Using a variety of tests, we find that the lowering of transaction costs is associated with a significant reduction in volatility for the aggregate NYSE portfolio and five size-ranked portfolios, even after accommodating market-wide conditional heteroskedasticity. In addition, prices are better characterized as random walks following the fixed fee abolition, a result that is due to a lower noise component in returns and more rapid price adjustment. We conclude that an increase in transaction costs could lead to higher volatility and less-informative prices.
JEL Classification: G12, G14, H23
Suggested Citation: Suggested Citation