Transaction costs are the costs investors pay when buying or selling securities. These may include brokerage, taxes, bid-ask spread, exchange fees, and other charges.
High transaction costs can reduce market efficiency because investors may avoid trading even when mispricing exists.
Example:
Suppose a stock is trading at ₹500 in one market and ₹508 in another market.
The price difference is:
₹508 – ₹500 = ₹8
But if the total transaction cost is ₹10 per share, the investor will not trade because the cost is higher than the possible profit.
Net profit:
₹8 – ₹10 = -₹2 per share
In this case, the price difference may remain because it is not profitable to correct it.
So, markets are efficient only within the limits of transaction costs.
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