62 ATaleofTwoMarkets
fragmented system with lots of different order books. The pressure
on all sides is revealed by merger talks between the NYSE and Nas-
daq on the one hand and between ECN leaders Instinet and Island
on the other.^20
Given this environment, elimination of transaction volatility is
unlikely. Not only that, any reduction in it through enhanced use of
electronic computer systems as opposed to market makers is likely
to be offset by another development in market trading: quoting share
prices down to the penny (“decimal pricing”) rather than in frac-
tional increments of 1/8 or 1/16.
In theory, decimal pricing would help produce prices that equal
value. Suppose the value of a share is $50.03. In a decimal pricing
system it is quoted at exactly $50.03, whereas in a fractional pricing
system it is quoted either at $50 or at $50.06 (i.e., 50 1/16).
Decimal pricing also has the effect of narrowing the bid-ask
spread for the same reason. But it means the spread is changed more
frequently, itself a cause of transaction volatility. While the move to
decimal pricing may not contribute as much to increasing transac-
tion volatility as the rise of ECNs subtracts, on balance the reduction
from ECNs makes only a modest case for improved market effi-
ciency.
The case is cloudier yet when you add the move toward 24-hour
trading. Market volatility tends to lighten when trading sessions are
interrupted, as occurs on the Thursday following Ash Wednesday,
for example. However, some of the greatest market plummets have
occurred on Mondays, following two days off. Whether continuous
trading will promote or retard efficiency is thus hard to predict,
though one lesson from history suggests the latter. The Evening
Exchange operated in New Yor kin the 1860s as a place to continue
trading stocks and gold after the NYSE’s regular daytime hours. It
lasted only a few years, apparently creating and suffering from a
staggering speculative and volatile bubble that led to its demise.^21
Whatever value ECNs add in terms of reduced transaction vol-
atility is offset by what they create in a third kind of volatility. The
rise of ECNs has meant a proliferation of places to trade and get
prices. For investors and traders, this means faster and cheaper ways
to trade stocks, at lower commissions, with swifter trade executions
and more after-hours trading. This promotes the democratization of
capital, which sounds nice. But is it?
As anyone who know anything about Warren Buffett knows, the
best investors see themselves as part owners of a business rather