Information and Trading on Electronic Communications Networks

The differences between ECNs and Nasdaq market makers are used to formulate and test several hypotheses about the choice of trading venue and the importance of ECN trades in the price discovery process. Trades are more likely to occur on ECNs when spreads are narrow and when trading volume and stock-return volatility are high. Medium and large trades on ECNs have lower effective spreads than comparable market-maker trades, although this is not the case for small trades unless they occur on noninteger ticks. ECN trades have greater permanent price impacts than market-maker trades implying that informed trades are more likely to occur on ECNs. Overall, more private information is revealed through ECN trades than through market-maker trades even though more trades occur with market makers.