Working Paper: NBER ID: w4727
Authors: Peter C. Reiss; Ingrid M. Werner
Abstract: This paper describes regularities in the intraday spreads and prices quoted by dealers on the London Stock Exchange. It develops a measure of spread-related transaction costs, one that recognizes dealers' willingness to price trades within their quoted spreads. This measure of transaction costs shows that trading costs are systematically related to a trade's size, characteristics of the trading counterparties, and security characteristics. Customers pay the full spread on small trades while medium to large trades receive more favorable execution. Market makers only discount very large customer trades while dealers regularly discount medium to large trades. Inter-dealer trades generally receive favorable execution, and discounts increase in size. Market makers do not discount trades with each other over the phone, but do discount when trading anonymously using inter-dealer-brokers. Quoted and touch spreads are falling in the number of market makers. The rate of decline is interpreted as reflecting economies of scale in market making.
Keywords: Transaction Costs; Dealer Markets; London Stock Exchange; Market Structure; Trading Costs
JEL Codes: G14; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| LSE rules (K20) | systematic discounts from posted prices (L42) |
| trade size (F19) | execution quality (C69) |
| trade size (F19) | likelihood of receiving a discount (L42) |
| identity of trading counterparties (L14) | transaction costs (D23) |
| trade size (F19) | dealer discounts (L42) |
| trading method (F10) | level of discount provided (H43) |
| dealer discounts (L42) | size of a trade (F10) |