Floor Brokers Research Articles

Vestigial Tails: Floor Brokers at the Close in Modern Electronic Markets

We study closing auction market quality on NYSE and Nasdaq. Closing auction volume for a stock is near-exclusive to its listing exchange, and now accounts for over 10% of its total volume. NYSE floor brokers can submit auction orders later than other traders, and their orders remain hidden until minutes before auction clearance. We show that auction information is less accurate and closing price efficiency is significantly worse on NYSE due to the late submission option. Auction quality improves when NYSE halted floor trading during the COVID-19 pandemic. Our results highlight the tradeoff between auction flexibility and efficiency.

Deviations from time priority on the NYSE

The New York Stock Exchange (NYSE) is the only U.S. equities exchange that offers parity allocation of all trades. Parity requires that orders from each floor broker, the designated market maker, and the top of the electronic limit order book trade together. Thus, floor trading interests can trade ahead of equally-priced, previously arriving orders in the limit order book. The presumption on the NYSE is that floor traders provide valuable services to the investing public and one approach to remunerating them for these services is deviating from strict time priority. Our research attempts to quantify the cost of this privilege.

Deviations from Time Priority on the NYSE

Most financial security trading venues prioritize competing liquidity providers with price-time priority; entities displaying the best-priced limit order earliest trade with the next opposite-sided liquidity-demanding order. The New York Stock Exchange (NYSE) rule putting traders “on parity” is a vestige of the traditional floor-based trading model and favors floor-based traders. Parity requires that orders from floor brokers, the designated market maker, and the top of the electronic limit order book trade together. That is, floor trading interests can trade ahead of equally priced, previously arriving orders in the limit order book. The NYSE posits that floor traders provide valuable services to the investing public and one approach to remunerating them for these services is deviating from strict time priority. The cost of the potential benefits of the NYSE’s business model is not transparent. Our research is an initial attempt to quantify this cost.

Folding: Integrating Algorithms into the Floor of the New York Stock Exchange

How does automation reshape markets? Existing sociological studies have argued that market automation need not entail a dilution of social relations, but the empirical evidence is inconclusive. Our multi-period ethnography of the New York Stock Exchange addresses this gap by exploring how the NYSE automated trading while preserving its floor intermediaries. Our study reports on observations in 2003 before automation was introduced, outlining the functions traditionally played by specialists and floor brokers. It then analyzes how the Exchange preserved these intermediary roles in 2006-08 as it introduced algorithmic order matching, and proposes the notion of folding to denote the process of automating a market while preserving its social structure. Finally, our analysis of the Flash Crash in 2010 suggests that folding allowed the NYSE to outperform its floorless rivals.

The Importance of Institutional Design: Evidence from the New York Stock Exchange IPO and Reg. NMS

For more than two hundred years, the New York Stock Exchange (NYSE) provided the dominant national platform upon which firms could list, and investors could trade, securities. Until 2006, the NYSE was organized as a private mutual non-profit firm whose membership, dominated by investment banks, maintained tight control over floor brokers, specialists and issuing firms. Even when over-the-counter markets such as the NASDAQ and alternative platforms such as “electronic communications networks” (ECN’s) offered faster execution of trades, NYSE floor quotes were protected against “trading through” to such competing venues (the so-called “trade-through” rule). The NYSE long argued that this framework provided highly liquid and continuous markets that lowered the cost of capital for, and incentivized good quality governance of, issuing firms. As a private monopoly the NYSE’s self-regulation periodically generated controversy, and the NYSE was finally subjected to serious government oversight in the 1930’s. In part based on that original Congressional mandate, in 2005, the Securities and Exchange Commission (SEC) began a two-year process of implementing Regulation NMS (for “national market system”). Most significantly, Reg. NMS, among other features, eliminated the protective “trade-through” rule thus enabling customers to trade off price quality for faster trade execution of trades on ECN’s. In 2006, in order to defend its place in the new post-“trade-through” world enabled by Reg. NMS, the NYSE demutualized and went public via a merger with Archipelago Holdings Inc., a large publicly listed ECN. We examine stock market data around the implementation of Reg. NMS and the NYSE IPO to show that eviscerating the “trade-through” rule triggered an explosion of new trading on alternative venues but also increased volatility in the pricing for formerly staid NYSE-listed shares. The end of the NYSE’s monopoly reduces choices for issuing firms as the NYSE no longer offers an “orderly market” for their listed shares. This increases the cost of capital for stable, well-managed firms and contributes to the reluctance of promising firms to go public thus eliminating a source of high-end customers for underwriters and undermining liquidity for investors. Reg. NMS and the NYSE IPO also likely encourage the formation of “dark pools” (transactions that take place outside of the regulated markets) and the spread of risky “high frequency” trading.

The value of the floor

Existing theoretical literature suggests that floor trading has discernable benefits over electronic trading. In particular floor relationships lead to a reduction in asymmetric information and hence lower spreads. The ability of floor brokers to participate in incoming order flow without revealing their supply and demand curves increases total liquidity and dampens liquidity shocks leading to lower volatility. We develop hypotheses and test them on a sample of stocks that switch from floor trading to an electronic system with fairly identical rules and pre-trade transparency. We find strong support for existing theory and our hypotheses. In particular asymmetric information and volatility are significantly higher on the electronic system. This leads to an increase in investor transaction costs which dwarfs the operational cost advantages of the electronic systems. Our results are robust to tests involving samples that control for company specific factors and market wide trends.

The Value of the Floor

Existing theoretical literature suggests that floor trading has discernable benefits over electronic trading. In particular floor relationships lead to a reduction in asymmetric information and hence lower spreads. The ability of floor brokers to participate in incoming order flow without revealing their supply and demand curves increases total liquidity and dampens liquidity shocks leading to lower volatility. We develop hypotheses and test them on a sample of stocks that switch from floor trading to an electronic system with fairly identical rules and pre-trade transparency. We find strong support for existing theory and our hypotheses. In particular asymmetric information and volatility are significantly higher on the electronic system. This leads to an increase in investor transaction costs which dwarfs the operational cost advantages of the electronic systems. Our results are robust to test involving samples that control for company specific factors and market wide trends.

Reputation Effects in Trading on the New York Stock Exchange

ABSTRACTTheory suggests that reputations allow nonanonymous markets to attenuate adverse selection in trading. We identify instances in which New York Stock Exchange (NYSE) stocks experience trading floor relocations. Although specialists follow the stocks to their new locations, most brokers do not. We find a discernable increase in liquidity costs around a stock's relocation that is larger for stocks with higher adverse selection and greater broker turnover. We also find that floor brokers relocating with the stock obtain lower trading costs than brokers not moving and brokers beginning trading post‐move. Our results suggest that reputation plays an important role in the NYSE's liquidity provision process.

Reputation Effects in Trading on the New York Stock Exchange

Theory suggests that reputations, developed in repeated face-to-face interactions, allow non-anonymous, floor-based trading venues to attenuate adverse selection in the trading process. We identify instances when stocks listed on the New York Stock Exchange (NYSE) relocate on the trading floor. Although the specialist follows the stock to its new location, most floor brokers do not. We use this natural experiment to determine whether reputation appears to affect trading costs. We find a discernable increase in the cost of liquidity in the days surrounding a stock's relocation. The increase is more pronounced for stocks with higher adverse selection and greater broker turnover. Using NYSE audit-trail data, we find that the floor brokers relocating with the stock obtain lower trading costs than those brokers who do not move and those that begin trading post-move. Together, these results suggest that reputation plays an important role in the liquidity provision process on the floor of the NYSE.

The impact of time duration between trades on the price of treasury note futures contracts

AbstractRecent research in finance has indicated that the institutional structure in which financial asset prices are determined can have a nontrivial impact on pricing. This report examines transaction level data for Treasury Note futures contracts traded at the Chicago Board of Trade (CBOT) to identify institutional, or market microstructure, impacts on the pricing of these contracts. Relatively few articles have conducted empirical research on the microstructure of U.S. futures trading due to the limited availability of comprehensive transaction level data from the futures exchanges. This report uses the CBOT's Computerized Trade Reconstruction database, a comprehensive transaction level dataset, to identify the price impact of the time duration between trades in a manner analogous to that of A. Dufour and R. F. Engle (2000). Unique differences from prior research include the application to futures contracts with their relative higher frequency of trading, as well as the investigation of the price impact of the number of active traders present on the trading floor and the trading volume. Subsequent price and sign of trade significantly relate to the time duration between trades, the number of floor brokers, and the trading volume. © 2004 Wiley Periodicals, Inc. Jrl. Fut Mark 24:965–980, 2004

Informed trading and order type

Each trader must choose between a limit order, a market order, or using a floor broker. We hypothesize that informed investors will: (1) concentrate their trading in floor broker orders and (2) sometimes trade patiently. Consistent with our hypotheses, empirical results suggest that most informed trading occurs through orders executed by floor brokers and that informed floor brokers are sometimes patient. Regardless of their patience, however, quote revisions following trade executions are consistent with the hypothesis that markets recognize that floor traders are more likely to be informed than other traders. As a result, informed trading moves equilibrium security values.

Informed trading and order type

Each trader must choose between a limit order, a market order, or using a floor broker. We hypothesize that informed investors will: (1) concentrate their trading in floor broker orders and (2) sometimes trade patiently. Consistent with our hypotheses, empirical results suggest that most informed trading occurs through orders executed by floor brokers and that informed floor brokers are sometimes patient. Regardless of their patience, however, quote revisions following trade executions are consistent with the hypothesis that markets recognize that floor traders are more likely to be informed than other traders. As a result, informed trading moves equilibrium security values.

How much do locals contribute to the price discovery process?

This paper studies the relative contribution of floor brokers and local floor members (locals) towards the price discovery process. Using detailed Share Price Index (SPI) futures contract data from the Sydney Futures Exchange (SFE), we construct 1- and 5-min series of volume weighted average prices for both floor brokers and locals. Estimates of Gonzalo and Granger [J. Bus. Econ. Stat. 13 (1995) 27] plus Hasbrouck [J. Finance 50 (1995) 1175] information shares reveal that trades initiated by locals account for approximately one-third of all price discovery within the market. Also, it is found that the locals' share of price discovery is higher than their share of trading activity. However, when there is high volatility or when observation intervals are lengthened, locals' contribution to price discovery declines. We conclude that although floor brokers are the main contributors, locals do play a significant role within the price discovery process.

Brokers and brokerage in the process of trading in commodity futures markets

This paper mainly deals with the analysis of a very complex process of brokerage in commodity futures markets. Unlike a classical commodity market in which brokers are not a necessity, sales and purchases in commodity futures markets cannot be carried out without brokers. Brokers who act as agents of buyers and sellers of futures are a necessary condition for trading in organized markets, such as commodity futures markets. The structure of brokers in futures trading is multilayer and involves participants in futures trading from floor brokers, immediate futures traders and the members of clearing and the clearing house itself, on the one hand, to numerous other necessary actors whose activities out of the stock exchange and the clearing house contribute to the efficient functioning of futures market. The fact that transactions between buyers and sellers in futures markets are not carried out directly but through brokers means that the obligations of buyers and sellers are formally conveyed to brokers, providing at the same time the guarantee by the broker that the actual buyer and the actual seller will fulfill their contractual obligations. At the very beginning of futures trading, the relationship between the seller and the buyer is transformed into a relationship between two brokers. Since that moment on, the original relationship is conveyed to higher levels of brokerage reaching the level of the clearing house. In the process of transformation of the buyer-seller relationship and transmitting obligations and guaranteeing their fulfillment, the clearing house itself becomes the buyer relative to all sellers and the seller relative to all buyers. In this way, it guarantees that obligations regarding all transactions in futures market will be fulfilled. The whole process is carried out in accordance with the prescribed procedures conducted on the floor of commodity exchange, in its administrative departments and in the clearing house itself.

NYSE order flow, spreads, and information

This paper uses unique NYSE audit trail data to evaluate spreads and information content for different order types. Actual spreads are positive for liquidity-demanding orders and negative for liquidity-supplying orders after controlling for order direction. However, because a large fraction of liquidity-demanding orders get price improvement, the actual spread for liquidity-demanding orders is up to 50 percent less than the Lee and Ready (1991) algorithm would suggest. Regression results show that the order composition of trades affects traditional measures of spreads and information. They also show that NYSE non-displayed liquidity reduces trading costs facing market orders, and that liquidity-demanding floor broker orders are the most informative order type.

The Economic Value of a Trading Floor: Evidence from the American Stock Exchange

This paper provides evidence that floor brokers add value that helps offset the higher cost of accessing the trading floor, making it a desirable venue for orders requiring more careful handling. We compare execution costs of non-block trades handled by Amex floor brokers with trades entered through its automated Post Execution Reporting (PER) system. Essentially, because floor traders can opportunistically seize liquidity without showing their hands too quickly, using a floor broker is equivalent to placing a 'smart' limit order. Overall, floor trades have a lower realized half-spread than PER trades (-3.06 bps versus 4.43 bps). This finding holds for other measures of execution costs as well and is consistent across all order-size categories. The light our findings shed on the value of intermediation in security markets also has implications for automated trading systems.

Market Structure and Trader Anonymity: An Analysis of Insider Trading

This paper examines the degree of anonymity—the extent to which a trader is recognized as informed—on alternative market structures. We find evidence that is consistent with less anonymity on the NYSE specialist system compared to the NASDAQ dealer system. Specifically, when corporate insiders trade medium-sized quantities (500–9,999 shares inclusive), NYSE listed stocks exhibit larger changes in proportional effective spreads than NASDAQ stocks. Taken together, these findings are consistent with Barclay and Warners (1993) contention that stealth (medium-sized) trades are more likely based on private information and insider trades are more transparent on the NYSE specialist system relative to the NASDAQ dealer system. The results support the hypothesis by Benveniste, Marcus, and Wilhelm (1992) that the unique relationship between specialists and floor brokers on the NYSE leads to less anonymity.

Who Trades Futures and How: Evidence from the Heating Oil Futures Market

We document the trading activities over the period from June 1993 through March 1997 of the 223 largest traders of heating oil futures - traders who together account for 58% of the open interest in this market. Dividing these traders into eleven different groupings: refiners, marketers/distributors, commercial banks, investment banks, end users, energy traders, other energy firms, commodity pools, commodity trading advisors, floor brokers, and other non-commercial traders, we explore how their trading activities differ and compare. While past studies have documented the trading of a single trader, a single type of trader, or traders in general, this is the first dis-aggregated study of all large traders in any derivatives market. We find substantial and significant differences between the eleven trader types in: their propensity to take long or short positions, whether they hold outright (naked) or spread positions, the term-to-maturity of the contracts they hold, how long they hold a position, and the size of their positions. We also find that both trading volume and open interest positions are dominated by potential hedgers, rather than speculators, where potential hedgers are defined as traders with substantial positions in the cash and/or forward heating oil market. Finally, we find that it is not appropriate to treat traders which the CFTC identifies as commercials as hedgers as is common practice in the finance literature.

Not Held Orders: Evidence on the Value of Order Timing in an Equity Market

This paper assesses the value of order timing in equity trading, with particular focus on the working of not held orders by floor brokers. To this end, we examine trades on the American Stock Exchange (Amex) using October 1996 proprietary trade and quote data for 838 stocks. Recognizing that access costs to the floor are relatively high, we compare the temporary price impact of orders handled by floor brokers with that of orders entered through the Amex's Post Execution Reporting (PER) system. We find that orders handled by floor brokers have a smaller temporary price impact than do PER orders (on average, 1.45 cents per share versus 3.29 cents per share). We also find that orders placed on the trading floor have higher information content, as measured by the permanent price impact of orders (on average, 5.90 cents per share versus 3.27 cents per share). The findings have implications for the development of electronic trading platforms for institutional participants concerned with controlling the market impact of their large orders.

The trades of NYSE floor brokers

This paper studies the contribution of NYSE floor brokers to the Exchange's agency auction market. Floor brokers represent 44%, specialists 11%, and system orders 45% of the value of all executed orders in our sample. We analyze how the cross-sectional distribution of floor broker trading depends on liquidity, block volume, on- and off-exchange competition, volatility, and order flow internalization. Floor brokers participate in large trades, primarily in liquid stocks, and they trade more when volatility is high. They provide two-sided liquidity to the market and often provide liquidity that would otherwise have been supplied by NYSE specialists.