Financial Market Design and Equity Premium: Electronic versus Floor Trading

We assemble the dates of announcement and actual introduction of electronic trading by the leading exchange of 120 countries to examine the long term and medium term impact of automation. Estimates from dividend growth model as well as international CAPM suggest a significant decline in expected returns after the introduction of electronic trading in the world’s equity markets, especially in the developing nations. Consistent with this reduction in equity premium in the long run, there is a positive short-term price reaction to the switch. These findings are sustained even after controlling for risk factors, economic growth, financial integration, and economic liberalization. Further analysis of trading turnover supports the notion that electronic trading enhances the liquidity and informativeness of stock markets leading to a reduction in cost of capital.