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Why Is the Bid Price Greater than the Ask? Price Discovery during the Nasdaq Pre-Opening

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  • Charles Cao
  • Eric Ghysels

    ()

  • Frank Hatheway

Abstract

One fundamental issue in the study of market microstructures is that of price discovery. While most existing studies focus on the trading period, little is known whether and how much the non-trading period contributes to the price discovery. This paper offers a new perspective on the price discovery process by studying market makers' posting and revising of non-binding prices on Nasdaq during the one-and-half hours pre-opening period. We examine a unique data set containing all the market maker quotes and identifications collected for 50 of the most active Nasdaq stocks. Our empirical investigation shows there is strong evidence that non-binding prices contain information, and there is significant price discovery during the pre-opening period. In the absence of trades, Nasdaq dealers use locked market notes (e.g., the situation where the best bid price among all market makers is greater than the best ask) as an important device to indicate to other market makers which direction the price should move and what the opening price should be. Furthermore, we find evidence that there exists a leadership pattern among market makers, particularly for the most active stocks. Chaque matin avant l'ouverture du Nasdaq il y a une session durant laquelle les faiseurs de marché font des cotations sans exécutions d'ordres. Malgré le fait qu'il n'y a pas de transactions pendant cette période, il s'y produit une activité importante de soumission et de révision des cotations. Nous étudions l'information révélée par les cotations de prix d'achat et de vente. Notre banque de données contient l'identification des participants, ce qui nous permet de tester plusieurs hypothèses sur la dynamique de la formation du prix d'ouverture. Nous trouvons notamment que certains faiseurs de marché prennent un role de leaders.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 98s-14.

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Date of creation: 01 May 1998
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Handle: RePEc:cir:cirwor:98s-14

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Keywords: Bid and ask prices; locked market quotes; pre-opening period; price discovery; Nasdaq market makers; Prix d'achat et de vente; pré-ouverture; Nasdaq;

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References

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  1. Battalio, Robert & Greene, Jason & Jennings, Robert, 1997. "Do Competing Specialists and Preferencing Dealers Affect Market Quality?," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 969-93.
  2. Glosten, Lawrence R. & Harris, Lawrence E., 1988. "Estimating the components of the bid/ask spread," Journal of Financial Economics, Elsevier, vol. 21(1), pages 123-142, May.
  3. Ananth Madhavan & Matthew Richardson & Mark Roomans, . "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," Rodney L. White Center for Financial Research Working Papers 20-94, Wharton School Rodney L. White Center for Financial Research.
  4. Bruno Biais & Pierre Hillion & Chester Spatt, 1999. "Price Discovery and Learning during the Preopening Period in the Paris Bourse," Journal of Political Economy, University of Chicago Press, vol. 107(6), pages 1218-1248, December.
  5. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  7. Barclay, Michael J. & Warner, Jerold B., 1993. "Stealth trading and volatility : Which trades move prices?," Journal of Financial Economics, Elsevier, vol. 34(3), pages 281-305, December.
  8. Godek, Paul E., 1996. "Why Nasdaq market makers avoid odd-eighth quotes," Journal of Financial Economics, Elsevier, vol. 41(3), pages 465-474, July.
  9. Easley, David, et al, 1996. " Liquidity, Information, and Infrequently Traded Stocks," Journal of Finance, American Finance Association, vol. 51(4), pages 1405-36, September.
  10. Bessembinder, Hendrik & Chan, Kalok & Seguin, Paul J., 1996. "An empirical examination of information, differences of opinion, and trading activity," Journal of Financial Economics, Elsevier, vol. 40(1), pages 105-134, January.
  11. Chan, K C & Christie, William G & Schultz, Paul H, 1995. "Market Structure and the Intraday Pattern of Bid-Ask Spreads for NASDAQ Securities," The Journal of Business, University of Chicago Press, vol. 68(1), pages 35-60, January.
  12. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  13. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Farrell, Joseph, 1995. "Talk Is Cheap," American Economic Review, American Economic Association, vol. 85(2), pages 186-90, May.
  15. Joseph Farrell & Matthew Rabin, 1996. "Cheap Talk," Journal of Economic Perspectives, American Economic Association, vol. 10(3), pages 103-118, Summer.
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