Headlines 2017

Tax-payers would save billions with new trading rules


Society could save billions of dollars every day if trading in commodities, energy and securities was made more competitive through a minor rule change, according to the new paper “Pro-competitive rationing in multi-unit auctions”, which is to be published in Economic Journal.

Changing the rules gives traders an incentive to buy or sell at more competitive prices, the research suggests, making trading more efficient – and therefore saving large sums for governments and other organisations that trade through auctions and exchanges.

“By changing the rules, even small reductions in transaction prices would still save a lot of money for society and tax payers,” says Pär Holmberg, associate professor in economics at the Stockholm’s Research Institute of Industrial Economics (IFN), and author of the research.

“For auctions with a high turnover, the cost to implement such a rule change would be negligible compared to the savings.”

Every day, auctions and exchanges around the world trade bonds, stocks, currencies, electricity, metals, commodities, securities and financial instruments worth trillions of dollars. 

2017-10-26 2ParHolmberg om trading rules.jpgPär Holmberg. Photo: Karl Gabor.

Most trading platforms apply “precedence rules”, which determine in which order instructions from traders should be executed – normally sell orders with a low ask price and buy orders with a high bid price are executed first. 

Precedence rules also decide how orders should be ranked in case of ties, for example when two traders submit sell orders with identical offer prices. Such a rule is often referred to as a “tie-breaker” or “rationing rule”. 

Sometimes priority is given to the order that was submitted first. Other exchanges might prioritise an order with a large volume over a small order with the same offer price, or even the other way around. 

The new tie-breaker developed at IFN is different in that orders with the same offer price are prioritised according to whether the offer price is high or low. 

Offers become more competitive if the rationing rule gives higher priority to sell orders with a small volume when ties occur at high offer prices. The effect is largest in markets such as security exchanges, where orders are entered at just a few price levels, so that rationing becomes more important. 

Under the most beneficial circumstances, the research shows that the new rationing rule would have the same effect as if the number of traders was doubled, thereby increasing the competition and forcing the trade to be conducted more efficiently.

In a procurement auction where sell orders are entered at 10 different price levels with a mark-up of around 10%, the procurement price can be reduced by roughly 1%. – leading to huge savings on large contracts. So government bodies that carry out procurement auctions or sell spectrum licenses, emission permits or treasury bills would save billions in tax payers’ money.

Savings would be similar in a sales auction when applying pro-competitive rationing to buy orders, but then the rationing rule should give higher priority to buy orders with a small volume when ties occur at low bid prices. 

By cleverly designing the tie breaker rules in this way, trading orders become less strategic and better represent the traders’ true preferences.

For more information, please contact: Pär Holmberg

Research Institute of Industrial Economics, Grevgatan 34 - 2 fl, Box 55665, SE-102 15 Stockholm, Sweden | Phone: +46-(0)8-665 45 00 | info@ifn.se