Are there Economies of Scale in Stock Exchange Activities?

This is the first paper that examines economies of scale in stock exchanges. The data employed in the study include cost and output statistics for 37 stock exchanges in four continents around the world for the year 1997. I estimate two traditional cost functions and find that ray (overall) scale economies exist only in the very large stock exchanges but that there are significant scale economies with respect to one of the outputs, ie the processing of trades. On the other hand, there are not equally clear scale advantages related to activities involving company-specific information. There are thus opposing forces, some tending to increase standardization and scale and others favouring the continuization of more localized facilities. The outcome of increasing competition may be not be the amalgamation of exchanges but instead the centralization of certain functions, eg the trading function, and continued realization of others on a decentralized basis. There is nonetheless an obvious incentive for closer and deeper cooperation between European stock exchanges.

Introduction: A stock exchange is an example of a type of firm that has been a local monopoly in most countries. However, location will no longer prevent stock exchanges from competing with each other, as intermediaries and investors seek efficient cross-border services. Barriers between European securities markets have been largely removed or overcome with the implementation of the OECD codes on free movement of capital by the end of 1980s and the Investment Services Directive by the mid-1990s. The technology is already sufficiently advanced and cheap to enable investors to trade via networks. This is evidenced on a global scale in the currency and bond markets. The recent success of EUREX is a good European example of how networks are able to replace a trading floor in another country. Within this context, the introduction of the euro can only speed up the development toward a single European market for financial services. This development also implies that location will gradually lose some of its importance for market places and that competition between financial centres, market places and securities firms will intensify.

Author: Markku Malkamäki

Source: Research Discussion Papers, Bank of Finland

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