Electronic communication networks, market makers, and the components of the bid‐ask spread

The purpose of this paper is to investigate how quotes originating via electronic communication networks (ECN)s affect trading costs.

In order to investigate the relations between trading costs and quotation venue, the bid‐ask spread is decomposed into its theoretical cost components associated with adverse selection, inventory handling, and order processing.

Stoll's adverse selection costs of ECN‐originated quotes relate positively to effective spreads, while Lin et al.'s adverse selection costs relate negatively to effective spreads.

The paper shows how trading costs relate to trading venue choice by decomposing the bid‐ask spread.