Equity Trading by Institutional Investors: Evidence on Order Submission Strategies

Abstract The trading volume channeled through off-market crossing networks is growing. Passive matching of orders outside the primary market lowers several components of execution costs compared to regular trading. On the other hand, the risk of non-execution imposes opportunity costs, and the inherent “free riding” on the price discovery process raises concerns that this eventually will lead to lower liquidity in the primary market. Using a detailed data set from a large investor in the US equity markets, we find evidence that competition from crossing networks is concentrated in the most liquid stocks in a sample of the largest companies in the US. Simulations of alternative trading strategies indicate that the investor’s strategy of initially trying to cross all stocks was cost effective: in spite of their high liquidity, the crossed stocks would have been unlikely to achieve at lower execution costs in the open market.

[1]  Donald B. Keim,et al.  The Cost of Institutional Equity Trades: An Overview , 1998 .

[2]  B. A. Ødegaard,et al.  To Cross or Not to Cross ? , 2000 .

[3]  Jack L. Treynor.  What Does It Take to Win the Trading Game , 1981 .

[4]  Charles M. Jones,et al.  Sixteenths: Direct Evidence on Institutional Execution Costs , 1999 .

[5]  Maureen O'Hara,et al.  Cream-Skimming or Profit-Sharing? The Curious Role of Purchased Order Flow , 1996 .

[6]  Puneet Handa,et al.  Limit Order Trading , 1995 .

[7]  Thierry Foucault,et al.  Order flow composition and trading costs in a dynamic limit order market 1 I am grateful to Bruno Bi , 1999 .

[8]  Y. Amihud,et al.  Asset pricing and the bid-ask spread , 1986 .

[9]  Frank Heinemann,et al.  Competition for Order Flow as a Coordination Game , 2001 .

[10]  L. Glosten.  Is the Electronic Open Limit Order Book Inevitable , 1994 .

[11]  M. Lipson,et al.  Execution Costs of Institutional Equity Orders , 1999 .

[12]  David Easley,et al.  Liquidity, Information, and Infrequently Traded Stocks , 1996 .

[13]  Sunil Wahal,et al.  Institutional Trading Costs and Alternative Trading Systems , 2002 .

[14]  Donald B. Keim,et al.  Empirical evidence on the behavior of institutional traders , 1995 .

[15]  Maureen O'Hara,et al.  Time and the Process of Security Price Adjustment , 1992 .

[16]  Andre F. Perold,et al.  The implementation shortfall , 1988 .

[17]  H. Kent Baker,et al.  Market vs. Limit Orders: The SuperDOT Evidence on Order Submission Strategy , 1997 .

[18]  Tim McCormick,et al.  Electronic Communications Networks and Market Quality , 2001 .

[19]  Edward Nelling,et al.  The Probability of Limit-Order Execution , 2000 .

[20]  Donald B. Keim,et al.  The Cost of Institutional Equity Trades , 1998 .

[21]  Duane J. Seppi.  Liquidity Provision with Limit Orders and a Strategic Specialist , 1997 .

[22]  Haim Mendelson,et al.  Consolidation, Fragmentation, and Market Performance , 1987, Journal of Financial and Quantitative Analysis.

[23]  Ian Domowitz,et al.  Pricing behavior in an off-hours computerized market , 1999 .

[24]  Christine A. Parlour.  Price Dynamics in Limit Order Markets , 1998 .

[25]  Lawrence Harris,et al.  Liquidity , Trading Rules and Electronic Trading Systems , 1990 .

[26]  Ian Domowitz.  Liquidity, Transaction Costs, and Reintermediation in Electronic Markets , 2002 .

[27]  Sunil Wahal,et al.  Institutional Trading and Soft Dollars , 1997 .

[28]  Terrence Hendershott,et al.  Price Discovery and Trading Costs after Hours , 2000 .

[29]  L. Harris.  Trading and Exchanges: Market Microstructure for Practitioners , 2002 .

[30]  Donald B. Keim,et al.  Transactions costs and investment style: an inter-exchange analysis of institutional equity trades , 1997 .

[31]  H. Mendelson,et al.  Market Microstructure and Securities Values: Evidence from the Tel Aviv Stock Exchange , 1996 .

[32]  Haim Mendelson,et al.  Crossing Networks and Dealer Markets: Competition and Performance , 2000 .

[33]  Duane J. Seppi.  Equilibrium Block Trading and Asymmetric Information , 1990 .

[34]  Sugato Chakravarty,et al.  An Integrated Model of Market and Limit Orders , 1995 .

[35]  James Angel.  Who Gets Price Improvement on the NYSE , 1994 .

[36]  T. Hendershott,et al.  Price Discovery and Trading After Hours , 2003 .

[37]  Walayet A. Khan,et al.  UNLISTED TRADING PRIVILEGES, LIQUIDITY, AND STOCK RETURNS , 1993 .

[38]  Bhagwan Chowdhry,et al.  Multimarket Trading and Market Liquidity , 1991 .

[39]  A. Lo,et al.  Econometric Models of Limit-Order Executions , 1997 .

[40]  Avanidhar Subrahmanyam,et al.  Market Liquidity and Trading Activity , 2000 .

[41]  Chester Spatt,et al.  An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse , 1995 .