Electronic communication networks, market makers, and the components of the bid‐ask spread

Abstract

Purpose

The purpose of this paper is to investigate how quotes originating via electronic communication networks (ECN)s affect trading costs.

Design/methodology/approach

In order to investigate the relations between trading costs and quotation venue, the bid‐ask spread is decomposed into its theoretical cost components associated with adverse selection, inventory handling, and order processing.

Findings

Stoll's adverse selection costs of ECN‐originated quotes relate positively to effective spreads, while Lin et al.'s adverse selection costs relate negatively to effective spreads.

Originality/value

The paper shows how trading costs relate to trading venue choice by decomposing the bid‐ask spread.

Citation

Shawn Strother, T., Wansley, J.W. and Daves, P. (2009), "Electronic communication networks, market makers, and the components of the bid‐ask spread", International Journal of Managerial Finance, Vol. 5 No. 1, pp. 81-109. https://doi.org/10.1108/17439130910932350