Best Execution: Can Institutional and Retail Investors Benefit from Fast and Fragmented Trading?

Abstract

Fast trading and fragmentation of volume make equity markets complex, leading retail and institutional investors to demand sophisticated brokerage services. In a sample of stock transactions in Swedish large-cap firms, we find that brokers who show high trading sophistication when trading their own book do not deliver comparable execution quality when trading on behalf of clients. Best execution legislation states that brokers should take all reasonable steps to maximize the execution quality when trading on behalf of clients. For institutional clients, the shortcoming in execution quality is primarily driven by brokers' inability to route the transactions to the trading venue with the best price. For retail clients, in contrast, the shortcoming is due to poor liquidity timing and a strong reliance on active executions. Only institutional block trades benefit from execution by sophisticated brokers.