Are the stock markets “rigged”? An empirical analysis of regulatory change

Volatile events in the stock market such as the 2010 Flash Crash have sparked concern that financial markets are “rigged” in favor of trading firms that use high frequency trading (“HFT”) systems. We analyze a regulatory change implemented by the SEC in 2007 by examining its effect on a key market metric, the bid-ask spread, an investor cost, and find that the regulatory shift, indeed, disadvantages investors. We link the implementation of this change to a shift in the volume of trades from a low-cost venue to a high-cost venue. We argue that this outcome is predicted by the incentives of the venues, non-profit stock exchanges owned by different types of members. The less-volatile, lower-cost New York Stock Exchange was owned by underwriters and included a specialist system that is less vulnerable to HFT tactics that can disadvantage investors.