Senior Lecturer in Finance, University of Bath
In the market microstructure literature, most research is conducted on transaction costs and origins and determinants of the bid-ask spread. Demsetz (1968, p. 35), who wrote the seminal work on bid-ask spread costs, defines transaction costs as the “cost of exchanging ownership titles.” Transaction costs are further reduced to the bid-ask spread and commission charges when all the costs of issuing the titles (i.e., transferring ownership) and the costs of being informed about the titles have been incurred.
Stoll (2006) suggests that commission charges are at historically all-time low levels. The substantial fall in commission charges results from two major changes in financial markets—the move to decimal pricing and market consolidation—leading to increases in the economies of scale in the cost of handling orders. A study on commission costs by Jones (2002) shows that commission costs on the New York Stock Exchange (NYSE) amount to about 0.12 percent of the transaction value, down from about 24 percent in 1994. Historically, until 1974, commission charges in the United States were linear in nature. That is, commission charges increased proportionately with trade size. However, deregulating commission charges in 1974 led to economies of scale in commission costs. Similarly, trading costs associated with the existence of the bid-ask spread have declined ...