Working Paper: NBER ID: w28515
Authors: Sida Li; Mao Ye; Miles Zheng
Abstract: Financial regulations and clientele segmentation explain the proliferation of order types on stock exchanges. Plain market and limit orders lose money, indicating that informed traders use complex orders. Fifty-seven percent of trading volume comes from non-routable orders, which are designed to bypass Reg NMS. Because Reg NMS routes orders based on the best gross prices, it often routes orders to worse net prices after adjusting for fees. Non-routable orders win speed races to capture short-term profits, but all order types containing long-term information are routable. An order type that complies with share repurchase regulations earns a 30-day return of 7%.
Keywords: financial regulation; clientele segmentation; order types; stock exchanges
JEL Codes: G14; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial regulations (G28) | Design and choice of order types (C69) |
| Reg NMS (G18) | Order routing and pricing outcomes (L11) |
| Segmentation of clientele (D26) | Development of specific order types (C69) |
| Complex order types (C69) | Compliance with financial regulations (G18) |
| Complex order types (C69) | Circumvention of existing regulations (G18) |
| Non-routable orders (C69) | Worse net prices (D49) |
| Routing of orders based on gross prices (C69) | Suboptimal outcomes for traders (D52) |
| Sophisticated order types (C69) | Short-term profits (G35) |
| ISOs (F53) | Price discovery (D47) |
| DNS limit orders (C69) | Better performance in returns (G17) |