Trade Execution Costs and Market Quality after Decimalization

Abstract

This study assesses trade execution costs and market quality for NYSE and Nasdaq stocks before and after the 2001 change to decimal pricing. Several theoretical predictions are confirmed. Quoted bid-ask spreads declined substantially on each market, with the largest declines for heavily traded stocks. The percentage of shares receiving price improvement increased on the NYSE, but not on Nasdaq. However, those trades completed at prices within or outside the quotes were improved or disimproved by smaller amounts after decimalization, and trades completed outside the quotes saw the largest reductions in trade execution costs, as a class. Effective bid-ask spreads as a percentage of share price, arguably the most relevant measure of execution costs for smaller trades, averaged 0.33% on a volume-weighted basis after decimalization for both NYSE and Nasdaq stocks. There is no evidence of systematic intraday reversals of quote changes on either market, as would be expected if decimalization had damaged liquidity supply.