Effect of the Internet on Financial Markets
Hal R. Varian
School of Information Management and Systems
University of California, Berkeley
September 1998
I review some academic work on electronic markets in an effort to provide
some guidance about future evolution of “cybermarkets” in the real world.
1 Retail transactions in financial services
Financial services, especially stock market trading, have been one of the
killer apps of the Internet. In 1996 there were about 1.5 million online bro-
kerage accounts; by the end of 1998 that number is expected to be 5.3 mil-
lion. Online accounts now are used for about 25% of all retail trades and
Forester Research forecasts 14.4 million online accounts by 2002. (Dwyer
et al. [1998])
These customers behave differently than traditional stockholders. The
online broker E-Trade1 claims its customers average 25 trades a year, which
is much more than customers of full-service brokerages (1-2 times per
year) or discount brokerages (4-6 times per year). (Harmon [1998]) There
are now 74 online brokers, whose intense competition has pushed com-
missions down to only $16 a trade, compared to $53 in 1996.
Mortgage refinancing has also benefited from advances in information
technology and the Internet in particular. Refinancing in Q1 1998 made
up about 57% of conventional mortgage applications, close to the record
of 58% set in 1993. According to Byrt [1998], this boom is due in large part
1http://www.etrade.com
1
DRAFT: Sept 24, 1998
2
to reduced transactions costs to refinance: borrowers can complete forms
online and the processing is highly automated. Closing points and fees
averaged 1.1% in July 1998, compared to 1.5% in 1993. The old rule of
thumb that a two-percentage-point drop in rates was required to generate
refinancing boom has now dropped to less than 0.75 percentage points due
to the reduction in transactions costs. (Byrt [1998])
Home banking, on the other hand, has been something of a disappoint-
ment. Currently, about 6 percent of customers use home banking, signifi-
can