Release Date: April 24, 2023
BUFFALO, N.Y. — Algorithms have increasingly replaced stock traders over the past few decades, but a new University at Buffalo School of Management study has found that market quality decreases when humans are removed from the equation.
Available online ahead of publication in the Journal of Finance, the study analyzed how the New York Stock Exchange was affected after floor trading was suspended in 2020 due to the COVID-19 pandemic. Of the 13 registered exchanges in the U.S., only the NYSE continues to use human floor traders — the rest are 100% electronic.
“Given the increasing popularity of algorithms, and the growing belief that artificial intelligence will disrupt labor markets, many have argued that floor traders are no longer necessary,” says study co-author Dominik Roesch, PhD, associate professor of finance in the UB School of Management. “But the closure of the NYSE trading floor due to COVID led to worse market quality across a variety of measures, including liquidity, price efficiency and auction quality.”
To examine the impact of floor traders on NYSE market quality, the researchers combined data from the Center for Research in Security Prices with the NYSE Trades and Quotes database. Using this data, they examined the relation between floor trading and various measures of market quality in a difference-in-differences framework — comparing the quality of NYSE stocks both before and after the suspension of floor trading, and comparing NYSE stocks to their equals on the NASDAQ exchange.
Their results show pricing errors for NYSE stocks increase by 2-6% after floor trading is removed, illustrating how humans continue to be valuable even in the age of algorithmic trading.
“Our results show floor traders are important contributors to market quality for two reasons,” says Roesch. “First, the floor facilitates the transfer of information in a way that electronic trading cannot, and second, clients can give brokers some latitude to work on their behalf when buying and selling, which improves outcomes.”
Roesch collaborated on the study with Jonathan Brogaard, PhD, the Kendall D. Garff Chaired Professor of Finance; and Matthew Ringgenberg, PhD, associate professor of finance; both from the University of Utah David Eccles School of Business.