Transparency matters: Price formation in the presence of order preferencing
AbstractUsing a market-making inventory model, we analyze the impact of order preferencing on dealers' quoting behavior by changing the degree of quote disclosure. We find that preferenced orders raise the inventory-holding costs of preferenced dealers, making them less able to post attractive quotes. In turn, competitors choose less aggressive prices, but still attract more likely public orders. Price competition is smoothed and expected market spreads widen. Promoting competition might be, however, enforced by (i) fine tuning through the degree of market transparency, (ii) favoring the entry of unpreferenced dealers, or (iii) requiring preferenced market-makers to have more funding capital.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Financial Markets.
Volume (Year): 14 (2011)
Issue (Month): 2 (May)
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Web page: http://www.elsevier.com/locate/finmar
Preferencing arrangements Inventory management Transparency Bid-ask spread;
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