Ryan Garvey and Anthony Murphy When traders place risky bets in securities markets, they incur transaction costs. Part of the cost of trading is explicit (e.g. broker commission) and the other part is implicit (e.g. dealer bid–ask spread). While implicit costs are frequently analyzed in financial studies, explicit costs receive little attention. This is likely due to researchers being able to estimate implicit costs from publicly available trade and quote data sources (e.g. NYSE TAQ),1 while explicit costs can only be analyzed by obtaining proprietary data from a brokerage firm. In addition, public data sources do not reveal trader identity, which makes it difficult to examine the influence of (implicit and/or explicit) transaction costs on individual trader behavior. In our study, we use proprietary data from a US brokerage firm that caters to active traders to examine how differences in explicit costs affect trader behavior. The data provide an ideal setting for isolating the effects of explicit costs on trader behavior. Although the retail and institutional traders in this firm have the same overall objective (to maximize their earnings from intraday trading), they pay very different commissions to the broker. Retail traders, who trade their own capital, pay a standard commission rate per trade. On the other hand, institutional traders, who trade the firm’s capital, negotiate their commissions with the firm and pay few (or no) commissions per trade. Our examination of trader behavior shows that active retail traders focus their trading on higher-priced stocks and hold onto...
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