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Bid-Ask Spreads with Indirect Competition among Specialists

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Author Info
Gehrig, Thomas
Jackson, Matthew O.

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Abstract

We examine the bid-ask quotes offered by specialists (or dealers) who face indirect competition from other specialists who trade in related assets. In the context of a simple model where investors have mean variance preferences, we characterize the equilibrium bids and asks quoted by K specialists in N assets, where some specialists may control more than one asset. We compare the equilibrium spreads as the number (and factor structure) of the assets each specialist controls is varied. It is shown that for some constellations of initial portfolio holdings and asset covariance it is socially preferable to have competing specialists, while for others it is socially preferable to have their actions coordinated (or to have one specialist control several assets). In a simple factor model, we show how the optimal specialist control structure depends on whether the assets trade as substitutes or complements. In some situations it is beneficial to have specialist power concentrated within industries, in other situations, across industries, and in yet other situations, not to be concentrated at all.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1648.

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Date of creation: May 1997
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Handle: RePEc:cpr:ceprdp:1648

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Related research
Keywords: Bid-Ask Spread Indirect Competition Market Structure

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Find related papers by JEL classification:
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  1. Christie, William G & Harris, Jeffrey H & Schultz, Paul H, 1994. " Why Did NASDAQ Market Makers Stop Avoiding Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1841-60, December. [Downloadable!] (restricted)
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  3. Asher Wolinsky, 1983. "Retail Trade Concentration Due to Consumers' Imperfect Information," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 275-282, Spring. [Downloadable!] (restricted)
  4. Christie, William G & Schultz, Paul H, 1994. " Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1813-40, December. [Downloadable!] (restricted)
  5. Hasabrouck, Joel & Sofianos, George, 1993. " The Trades of Market Makers: An Empirical Analysis of NYSE Specialists," Journal of Finance, American Finance Association, vol. 48(5), pages 1565-93, December. [Downloadable!] (restricted)
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  9. Stahl, Dale O, II, 1988. "Bertrand Competition for Inputs and Walrasian Outcomes," American Economic Review, American Economic Association, vol. 78(1), pages 189-201, March. [Downloadable!] (restricted)
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  12. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December. [Downloadable!] (restricted)
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