Payment for Order Flow And Asset Choice / Thomas Ernst, Chester S. Spatt.

Format:

Book

Author/Creator:

Ernst, Thomas.

Contributor:

National Bureau of Economic Research.

Spatt, Chester S.

Series:

Working Paper Series (National Bureau of Economic Research) no. w29883.

NBER working paper series no. w29883

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2022.

Summary:

The paper documents important differences in payment for order flow (PFOF), spreads, and price improvement across asset classes. In stocks we show that PFOF is small. While many retail trades are executed off-exchange, we find that they receive meaningful price improvement, particularly when spreads are at their minimum. In single-name equity options, we show that PFOF is large. While all option trades are executed on-exchange, option exchanges have rules that facilitate internalization. We exploit variation in the Designated Market Maker (DMM) assignments at option exchanges to show that retail traders receive less price improvement, and worse prices, from those DMMs who pay PFOF to brokers. Current debate concerning PFOF has focused on equity routing. We show that option routing is comparatively worse, and this gives rise to a second potential conflict of interest of brokers: encouraging customers to trade assets offering higher PFOF. As fintech has eliminated retail commissions, these cross-asset differences in PFOF have become far more consequential to broker incentives.

Notes:

Print version record

March 2022.