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

Posted: 22 Oct 2006  

George J. Benston

Emory University - Department of Accounting

Robert Wood

University of Memphis - Fogelman College of Business and Economics

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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 in these markets of relative effective spreads (RES), 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 and other liquidity providers 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 from small-trade-size investors. NASDAQ market makers' response to these losses and additional operations costs incurred to reduce the losses resulted in greater RES and increased trading within the best quotes, predominantly on larger trade sizes. The data are consistent with the "SOES-day-trading" hypotheses, but not with the other two. Furthermore, the mandatory SOES "experiment" provides insights into the negative effects of automated trading systems (such as ECNs, which now dominate NASDAQ) when their design does not adequately consider opportunistic traders.

Keywords: Market microstructure, NASDAQ, NYSE, bid-ask spreads, odd-eighth avoidance

JEL Classification: G14, G18, L12, L22, G12, G18, D23, D82, D83

Suggested Citation

Benston, George J. and Wood, Robert, Why Effective Spreads on Nasdaq Were Higher than on the New York Stock Exchange in the 1990s. Journal of Empirical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=939036

George J. Benston (Contact Author)

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)

Robert A. Wood

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

Memphis, TN 38152
United States
901-678-2670 (Phone)
901-678-3006 (Fax)

HOME PAGE: http://www.people.memphis.edu/~rwood/

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