The effect of settlement regimes on trading cost and market efficiency: evidence from the National Stock Exchange

Abstract

Using data from 65 of the most actively traded stocks from the National Stock Exchange of India we study the relationship between impact cost and three indicators of market efficiency under different settlement regimes. Our data is uniquely suited for this study because it encompasses a transition by the National Stock Exchange of India from fixed to rolling settlement. As a by-product of our study we are able to examine inefficiencies related to the day of the week on which trades are conducted for different settlement regimes. In summary our data reveals that rolling settlement reduces aggregate impact costs, leading to greater market efficiency. Employing a fixed effects model we show that impact cost has a stronger relationship to our indicators of market efficiency under rolling settlement. However, we find evidence of two structural inefficiencies related to the day-of-the-week on which trades are conducted: 1) under rolling settlement, trades conducted earlier in the week (and settled by Thursday) have lower impact costs, and 2) there is an impact cost premium for Friday trades.