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September 30, 2000

Study: Decimals Cut Into Dealers' Profits

By William Hoffman

Decimalization is cutting into dealers' profit margins, according to a study by two finance professors.

The study concludes that quoted bid-ask spreads have declined "dramatically" in all 13 stocks taking part in the pilot decimalization program. On the American Stock Exchange, a decline of about 47 percent was noted for the six stocks in the program, while spreads shrunk by about 15 percent for the seven New York Stock Exchange Stocks taking part.

Dr. Robert Wood of the University of Memphis, who co-wrote the study with Dr. Sugato Chakravarty of Purdue University, said it was too early to draw conclusions.

Limited Program

Decimal-priced trading in a limited number of stocks started on Aug. 28. Nasdaq is expected to start pricing in decimals in March. All U.S. stocks, moreover, are slated to trade in decimals the following month.

The study, which took data from just before and immediately after the introduction of decimals, found that effective bid-ask spreads also fell, on average, by about 47 percent at the Amex and by 38 percent at the Big Board.

The effective bid-ask spread was defined by the professors as "twice the absolute difference between the transaction price and the midpoint of the prevailing quoted bid/ask spread."

Among traders, the impact of decimilization was generally uneventful. The manager of equity trading at one large mutual fund observed that decimal prices on U.S. stocks seem to be congregating near their equivalent fractional values.

Thus, a stock trading at 16 and one-half under the old order posts around $16.50 in the new scheme. The mutual fund trading manager said he observed the same transitory phenomena when stock prices converted from eighths to sixteenths. (The trader was contacted by telephone in the early phase of the pilot, noting that his desk had not yet traded decimal-priced stocks.)

Technical Glitches

A few glitches have been rumored. James H. Lee, president of Momentum Securities, in New York, said associates told him that some third-party vendors who redistribute quotes are experiencing technical problems reliably and quickly converting prices from fractions to decimals.

The trading manager at the mutual fund said the investing public probably is likely not in tune with decimals.

"I don't think the investing public in general knows that Gateway now trades in decimals," he said.

Yet with heavyweights America Online, Goodyear Tire, and Time-Warner joining the march to penny pricing day traders were expected to take advantage of brokers' slimmer profit margins. That may speed public acceptance of decimalization, a trader said.

"After that, we should have a much better feel for how our systems will handle the continuing decimalization of stocks," he said.

Meanwhile, Congress and the Securities and Exchange Commission are monitoring decimalization. "Our responsibility is to regulate the markets," said SEC spokesman John Heine, "so we're involved in watching them, too."