Optimal Fee Pricing

We show that the trading-fee breakdown (fee pricing) depends on the distribution of investor gains-from-trade relative to the tick size. Absent price discreteness, an increase in investor gains-from-trade increases the total fee proportionally, but the fee breakdown has no effect. With price discreteness, the fee breakdown can mitigate the loss of welfare due to difficulty in trading when gains-from-trade are small relative to the tick size. However, when gains-from-trade are large, the exchange fee breakdown plays only a small role and exchanges extract rents from investors gains-from-trade by increasing total fee. The resulting gap between welfare relative to fees set by a Social Planner can be large. Consequently, a regulator can improve welfare substantially by imposing a cap on exchange fees