Trading Costs on a Limit Order Book Market: Evidence from the Paris Bourse

Abstract

This paper provides estimates of the trading costs (and its components) for the CAC 40 index stocks traded on the limit order market of the Paris Bourse. An ECN is an electronic limit-order book that anonymously and automatically matches buy/sell orders. The Paris Bourse is a limit order book market and so provide the same structure and the same service than an ECN. Results indicate that a smile effect related to the trade size characterizes the posted spread and the relative posted spread. Moreover the traded spread accounts for about 85% of the posted spread and contains a large order processing component (82%) relative to the adverse selection cost (10.12%) and the inventory component (8.34%). It can be shown that these components are positively related to the trade size. This is particularly true when one considers the marginal cost of trading the largest quantities. The hypothesis that informed traders split their order is empirically checked. Adverse selection component is equal to 10.30% for small-size transactions and 8.86% for medium-size transactions. The traded spread is characterized by a large asymmetric component at the beginning and at the end of the trading day. Inventory holding cost follows an inverse-U shaped pattern: it ranges from 6.73% to 5.40%. Finally the conditional probability of a reversal in the order flow appears constant and equals to 0.26.