Hidden Liquidity Inside the Spread

Using a sample of 300 NYSE listed securities and excluding trade reporting facility trades, we examine the impact of order executions inside of the posted spread on market centers, an inside the spread trade(IST). The posted spread on a market center may differ from the National Best Bid and Offer Quote (NBBO). IST volume represents a substantial portion of daily volume executed at market centers, averaging 14%. However, only 51% of these trades improve on NBBO prices. Although the volume is substantial, cost savings from IST's is small, averaging $132 per stock day. We find evidence that hidden liquidity inside the spread tends to act as a loss leader, drawing additional trades after the successful execution of liquidity inside the spread. When an exchange's quotes are competitive with the NBBO, the probability of observing an IST is lower but when intermarket competition is high the probability of observing an IST increases. We find that IST's are generally uninformed. Our results are robust to firm size and trading intensity