Dec 3, 2021 - Economy & Business

Payment for order flow isn't so bad, analysis finds

Picture of a hand holding a phone with the Robinhood logo displayed on the screen
Photo: Omar Marques/SOPA Images/LightRocket via Getty Images

Is payment for order flow (PFOF) bad for investors? Absolutely not, according to a new paper from S.P. Kothari and Eric So of MIT.

What's new: PFOF is back in the news, now that Public has come out with data showing that the alternative — trading directly on exchanges — can result in significantly better execution quality.

  • The MIT paper — which was commissioned and paid for by Robinhood — pushes back against that conclusion.

What they found: The researchers found that the price improvement for retail investors using Robinhood was better than the price improvement that institutional investors receive when they trade small lots on public exchanges.

  • Be smart: As So of MIT tells Axios, that's because "market makers know they are unlikely to be trading with a sophisticated institutional investor with an information advantage."

The big picture: Retail investors get better execution than institutional investors. The new paper shows that decisively.

  • What's still up in the air, however, is whether retail investors are better served by the Robinhood PFOF model, or by the Public model of trading on exchanges.
  • Public has been making a concerted effort to find on-exchange counterparties who know that they're trading with retail investors rather than smart institutions, and are therefore likely to offer better prices. The NYSE and IEX exchanges already make that possible, and such setups are likely to expand.

The bottom line: Both models are good for retail investors, who now live in a blissful world where $0 trading fees are standard. The differences between the two models, if any, are always going to be small.

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