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The Hidden Cost of `Zero-Commission';

Published: 17 December 2024 Publication History

Abstract

In today's financial landscape, traditional exchanges compete against online trading platforms. A critical point of competition centers around transaction costs. While traditional exchanges adhere to transparent transaction cost structures, many online trading platforms, under the guise of 'zero-commission trading,' conceal transaction costs within their bid-ask spread. In this paper, I show that hidden transaction costs induce additional volatility in the form of price cycles in markets that would be stable if transparent transaction costs were charged. To compete with the profit opportunities from price cycles on platforms with hidden transaction costs, platforms with transparent costs must reduce them below the optimal monopolist level to attract traders. In this duopoly, I show that there is a market equilibrium: more risk-averse traders prefer transparent transaction costs, while less risk-averse traders choose hidden costs. Depending on the risk attitudes of traders, transparent transaction costs can be more or less efficient than hidden transaction costs. Finally, I demonstrate that the price cycles in markets with hidden transaction costs can be exploited through strategic market entry to a point where the platform ceases to make any revenue, highlighting the necessity of uninformed traders for sustaining zero-commission models.
The full paper is available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4861066.

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cover image ACM Conferences
EC '24: Proceedings of the 25th ACM Conference on Economics and Computation
July 2024
1340 pages
ISBN:9798400707049
DOI:10.1145/3670865
Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for profit or commercial advantage and that copies bear this notice and the full citation on the first page. Copyrights for third-party components of this work must be honored. For all other uses, contact the owner/author(s).

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Association for Computing Machinery

New York, NY, United States

Publication History

Published: 17 December 2024

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  1. financial markets
  2. transaction costs
  3. market design
  4. platform competition

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EC '24
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Overall Acceptance Rate 664 of 2,389 submissions, 28%

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