Research on information economics and securities markets dating back to Stigler argues that trading will tend to centralize in major market centers such as the New York Stock Market (NYSM). The NYSE’s recent mergers with Archipelago and Euronext bring questions about the viability and effects of competition between stock exchanges to the policy forefront. We examine the largely forgotten but unparalleled episode of competition between the NYSE and the Consolidated Stock market of New York  from 1885 to 1926.The Consolidated averaged 23% of NYSE volume for approximately forty years by operating a second market for the most liquid securities that traded on the Big Board. Our results suggest that NYSE bid-ask spreads fell by more than 10% when the Consolidated began to trade NYSE stocks and subsequently increased when the Consolidated ceased operations. The empirical analysis suggests that this historical episode of stock market competition improved consumer welfare by an amount equivalent to US$9.6 billion today.

Technological changes and globalization have given rise to a number of competitors that could threaten the New York Stock Exchange’s (NYSE’s) preeminent position in financial markets. The NYSE has identified the growth of global capital markets and the emergence of electronic communications networks as significant threats to its dominant market share . The NYSE has responded to this challenge by merging with a leader in new technology (Archipelago) and with the world’s leading cross-border exchange (Euronext).

These mergers raise many questions about stock market competition. An important question is whether stock marketcompetition is viable. The seminal analysis of Stigler on the economics of information and on securities markets argues that trading will tend to centralize in one location. More recent models of market microstructure such as those of Chowdry and Nanda also predict that liquidity is enhanced with centralized trading. Hence, related questions include the effect of stock market competition on the cost of transacting and on consumer welfare.

Unfortunately, prior empirical evidence offers little insight into these important public policy questions about stock market competition. Research focusing on past and more recent episodes of direct trading competition with the NYSE has studied relatively minor magnitudes of off-exchange trading by regional exchanges and/or the third market.

Our analysis focuses on the effects of competition on NYSE bid-ask spreads. We first study the impact of competition on bid-ask spreads when the Consolidated began to trade NYSE stocks in 1885. Then we analyze the effects of competition on bid-ask spreads for the forty-plus years of the stock exchange rivalry. Our results suggest that NYSE bid-ask spreads fell by more than 10% when the Consolidated began to trade NYSE stocks. We find that the presence of competition significantly reduced bid-ask spreads over the entire 42-year period of head-to-head competition. Bid-ask spreads then increased after the rival exchange closed its doors in 1926 following a series of scandals and investigations. Finally, we estimate that the Consolidated improved consumer welfare by an amount equivalent to US$9.6 billion today.

The remainder of the paper proceeds as follows. Section II describes the trading environment at the onset of competition as well as the evolution of stock market competition between the two rival exchanges. Section III analyzes the short- and long-run effects of competition on NYSE bid-ask quotes. This is followed by an analysis of the effect of the stock market rivalry on consumer welfare. Section IV summarizes the results and concludes the paper with a discussion of the implications of our findings for future studies of stock market competition.