When Transactions Went High-Tech - a Cross-Sectional Study of Equity Trading Costs in the Light of More Sophisticated Trading Systems

Abstract

This study aims at comparing the costs of trading at the larger European stock exchanges based on material computed by the Elkins/McSherry consultancy. We will evaluate the evolvement over time, and across exchanges.

We find that it's essential to distinguish between the different components of the trading costs. As a consequence, we will break down the total costs into an explicit part and an implicit part, instead of looking at the total levels. The implicit part measures the indirect costs of the trade execution, that being the market impact. Whilst the explicit cost is the amount of fees plus other direct payable costs relating to the trade. Main reason for this is the fact that these components have dissimilar natures and thus different main drivers.

Based on figures for the last 8 years we find that the cost levels have varied significantly both over time as well as among exchanges. Derived from both an empirical and a statistical analysis we find that the explicit cost levels have been declining significantly the last years with up to 35 percent. Hence, a drop that has caused the general costs to drop as well.

Indications prove that the cost levels among exchanges have been clustering the last couple of years. Further analyses of the cost figures for 2004 indicate that the explicit costs of trading are approximately identical across the major European markets, when adjusting for extraordinary stamp duties on the buy side at the London Stock Exchange. The effect of this recent development leads us to conclude that firstly the levels have clustered around a common mean, and secondly that the general cost levels have declined.

When examining the different cost drivers we identify the system turnover as a statistical significant explanatory variable for both the implicit and the explicit cost measure, thus for all three costs measures. A relationship that has not been pointed out in previous work. According to our results, one would expect both the implicit and explicit costs to depreciate as the system activity appreciates. These links serves as evidence of the fact that coalescing trading systems might imply lower future trading costs.

Keywords: transactions cost, trading systems, hybrid markets, implicit versus explicit trading costs

JEL Classification: G10