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 Originality/value - The paper shows how trading costs relate to trading venue choice by decomposing the bid-ask spread.