The authors show that increased trading on ECNs improves most measures of overall market quality. In the cross section, more ECN trading is associated with lower quoted, effective, and realized spreads, both overall and on trades with market makers. More ECN trading is also associated with less quoted depth. Parlour and Rajan develop a dynamic model of price competition in broker and dealer markets. Competing market makers quote bid-ask spreads, and competing brokers choose a commission to be paid by an investor.
Brokers also choose a routing strategy across market makers.
Then, to minimize their total transaction costs, investors choose a broker. This environment changes the order mix and can make retail investors worse off. It leads to lower brokerage commissions but higher market-maker spreads, thereby increasing the total transactions cost for investors. Spreads gradually declined over the course of the century but are punctuated by sharp rises during periods of market turmoil. Proportional one-way commissions rise dramatically to a peak of nearly one percent in the late 1960s and early 1970s, and fall sharply following commission deregulation in 1975.