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Transparency matters: Price formation in the presence of order preferencing

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Author Info

  • Lescourret, Laurence
  • Robert, Christian Y.

Abstract

Using 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 Info

Article provided by Elsevier in its journal Journal of Financial Markets.

Volume (Year): 14 (2011)
Issue (Month): 2 (May)
Pages: 227-258

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Handle: RePEc:eee:finmar:v:14:y:2011:i:2:p:227-258

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Web page: http://www.elsevier.com/locate/finmar

Related research

Keywords: Preferencing arrangements Inventory management Transparency Bid-ask spread;

References

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Cited by:
  1. Lescourret, Laurence, 2012. "Non-Fundamental Information and Market-Makers' Behavior during the NASDAQ Preopening Session," ESSEC Working Papers WP1212, ESSEC Research Center, ESSEC Business School.

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