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Price Experimentation and Security Market Structure

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Author Info
Leach, J Chris
Madhavan, Ananth N

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Abstract

We examine the role of market makers in facilitating price discovery. We show that a specialist may experiment with prices to induce more informative order flow, thereby expediting price discovery. Market makers in a multiple-dealer system, unlike a specialist system, do not have the incentives to perform such costly experiments because of free-rider problems. Consequently, the specialist system may provide open markets where bid-ask spreads. We analyze the effect of experimentation on the bid-ask spread and provide an exploratory analysis of intraday specialist data that is consistent with our price experimentation hypothesis. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 6 (1993)
Issue (Month): 2 ()
Pages: 375-404
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Handle: RePEc:oup:rfinst:v:6:y:1993:i:2:p:375-404

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  1. George J. Mailath & Georg Noldeke, 2007. "Does Competitive Pricing Cause Market Breakdown under Extreme Adverse Selection?," PIER Working Paper Archive 07-022, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
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  2. Charles Goodhart & Takatoshi Ito & Richard Payne, 1995. "One Day in June, 1994: A Study of the Working of Reuters 2000-2 Electronic Foreign Exchange Trading System," NBER Technical Working Papers 0179, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Robert Engle, 1999. "Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market," University of California at San Diego, Economics Working Paper Series 1999-05, Department of Economics, UC San Diego. [Downloadable!]
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  4. Richard K. Lyons, 1993. "Optimal Transparency in a Dealership Market with an Application to Foreign Exchange," NBER Working Papers 4467, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. George J. Mailath & Georg Noldeke, 2006. "Extreme Adverse Selection, Competitive Pricing, and Market Breakdown," Cowles Foundation Discussion Papers 1573, Cowles Foundation, Yale University. [Downloadable!]
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  6. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2005. "The joint dynamics of liquidity, returns, and volatility across small and large firms," Staff Reports 207, Federal Reserve Bank of New York. [Downloadable!]
  7. Alfonso Dufour & Robert Engle, 1999. "Time and the Price Impact of a Trade," University of California at San Diego, Economics Working Paper Series 1999-15, Department of Economics, UC San Diego. [Downloadable!]
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  8. Jan Krahnen & Martin Weber, 2001. "Marketmaking in the Laboratory: Does Competition Matter?," Experimental Economics, Springer, vol. 4(1), pages 55-85, June. [Downloadable!] (restricted)
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  9. Toni Gravelle, 2002. "The Microstructure of Multiple-Dealer Equity and Government Securities Markets: How They Differ," Working Papers 02-9, Bank of Canada. [Downloadable!]
  10. Victoria Saporta & Giorgio Trebeschi & Anne Vila, . "Price formation and transparency on the London Stock Exchange," Bank of England working papers 95, Bank of England. [Downloadable!]
  11. Osler, Carol & Mende, Alexander & Menkhoff, Lukas, 2006. "Price Discovery in Currency Markets," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-351, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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