Study finds concerns about Nasdaq trading systems unfounded


Conventional wisdom on Wall Street has held that the expanded use of electronic communication networks (ECNs) to bypass Nasdaq market makers would result in market fragmentation.p. But a new study finds that isn’t the case at all.p. ECNs are trading systems that automatically match buy and sell orders at specified prices, allowing customers to trade stocks directly, often with the prospect of lower fees.p. In an analysis of the most active Nasdaq stocks, Roger Huang at the University of Notre Dame reports that ECNs not only posted informative quotes, but they also posted quotes rapidly and more often at the inside, compared to market makers. His study also found that ECN quoted spreads are smaller than dealer quoted spreads.p. “There is widespread concern about the deleterious effects of market fragmentation resulting from the proliferation of alternative trading venues,” Huang writes in the study published in the June issue of the Journal of Finance. “The results of this paper suggest that this concern may have been misplaced, and that, in fact, the emergence of ECNs has had the opposite effect of enhancing quote quality.”p. Huang’s findings come at a pivotal time for Nasdaq. In order to compete more effectively with the ECNs, the second largest U.S. stock market is scheduled to launch a new trading execution system called SuperMontage in the next few months. At the same time, the four leading rival ECNs ? which all operate within the Nasdaq system ? recently have merged, Instinet with Island and Archipelago with RediBook. The fallout from these moves will do much to determine the future of Nasdaq.p. Huang joined the Notre Dame faculty two years ago as the Kenneth R. Meyer Chair in Global Investment Management and the chair of the finance and business economics department. He is a leading authority on all aspects of international financial markets, including stock price behavior, foreign exchange markets, fixed-income markets, derivatives and world equity markets.

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