Disclosure of information on order execution practices of market centers: How can investors utilize it?

Financial Services Review, Summer 2004 by Saraoglu, Hakan, Ascioglu, N Asli

Based on these findings, it is important for investors to be able to compare market centers for the quality of execution of their orders. Rule 11Ac1-5 is intended to increase access to information about how securities transactions are executed, hence enhancing investors' ability to make choices on the basis of execution criteria important to their particular needs. Rule 11Ac1-5 states that "market centers that trade national market system securities (specialists, over-the-counter "OTC" market makers, and ATSs) would be required to make available to the public monthly electronic reports that include uniform statistical measures of execution quality on a security-by-security basis." As a result of Rule 11Ac1-5, investors now have access to uniform statistics of order execution quality provided by each market center. Although the availability of such information is very valuable, it is difficult especially for individual investors to act on it without a proper framework. We suggest that information on the performance of competing market centers can be utilized in a multi-attribute evaluation framework in which investors can rank various market centers based on a set of performance criteria. Full-service brokerage firms, on-line brokers, and financial planners can offer a service that uses the AHP to help investors identify a market center and an order type that are suitable to their personal needs and preferences. Such a service would be useful not only as an evaluation framework but also as a reliable repository of the disclosure data.

3. Using the AHP for evaluating the execution quality of market centers

The AHP, which was developed by Saaty (1977, 1980), is a tool that helps decision-makers solve complex multi-attribute problems. It is commonly used to rank competing alternatives based on a set of evaluation criteria, and it has been applied to a variety of problems in finance, such as determining investor suitability (Bolster et al., 1995), selecting mutual funds (Saraoglu & Detzler, 2002), assigning sovereign debt ratings (Johnson et al., 1990), selecting a life insurance contract (Puelz, 1991), and determining an optimum portfolio mix (Khaksari et al., 1989).

Comparison of execution quality in markets centers and making choices on the basis of execution criteria are typical multi-attribute decision-making problems that can be solved using the AHP framework. In the following section, we present an example in which we rank market center-order type pairs based on the execution quality of small orders of the Nasdaq 100 Trust Series I (QQQ).

4. An example: evaluating the execution quality of market centers for QQQ

The first step in the AHP is to represent a given decision problem in a hierarchical structure, which typically includes three levels: the overall objective of the decision, the assessment criteria, and the competing alternatives. Fig. 1 presents the hierarchy of evaluating the order execution quality in different market centers for a hypothetical investor. In this case, the overall objective is to recommend to an investor a suitable order type and market center for the execution of a small order of QQQ. The assessment criteria are the different component measures of order execution quality for the investor, and the 25 market center-order type pairs are the competing alternatives. The hierarchy in Fig. 1 is kept simple for illustration purposes, and can be easily modified to include additional assessment criteria and market centers.