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Imperfect Market Monitoring and SOES Trading

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Author Info
Foucault, Thierry
Röell, Ailsa A
Sandås, Patrik

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Abstract

We develop a model of price formation in a dealership market where monitoring of the information flow requires costly effort. The result is imperfect monitoring, which creates profit opportunities for speculators, who do not act as dealers but simply monitor the information flow and quote updates in order to pick off 'stale quotes'. Externalities associated with monitoring can help to sustain non-competitive spreads. We show that protecting dealers against the execution of stale quotes can result in larger spreads and be detrimental to price discovery due to externalities in monitoring. A reduction in the minimum quoted depth will reduce the spread and speculators' trading frequency. Our analysis is relevant for the SOES debate given that the behaviour of speculators in our model is very similar to the alleged behaviour of the real world SOES 'bandits'.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2265.

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Date of creation: Oct 1999
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Handle: RePEc:cpr:ceprdp:2265

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Related research
Keywords: Automatic Execution; Bid-Ask Spread; Monitoring; SOES;

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Find related papers by JEL classification:
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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  1. Harris, Jeffrey H. & Schultz, Paul H., 1998. "The trading profits of SOES bandits1," Journal of Financial Economics, Elsevier, vol. 50(1), pages 39-62, October. [Downloadable!] (restricted)
  2. Kandel, Eugene & M. Marx, Leslie, 1999. "Odd-eighth avoidance as a defense against SOES bandits1," Journal of Financial Economics, Elsevier, vol. 51(1), pages 85-102, January. [Downloadable!] (restricted)
  3. Michael J. Barclay & William G. Christie & Jeffrey H. Harris & Eugene Kandel & Paul H. Schultz, 1999. "Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks," Journal of Finance, American Finance Association, vol. 54(1), pages 1-34, 02. [Downloadable!] (restricted)
  4. Battalio, Robert H. & Hatch, Brian & Jennings, Robert, 1997. "SOES Trading and Market Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(02), pages 225-238, June. [Downloadable!]
  5. Kandel, Eugene & Marx, Leslie M., 1997. "Nasdaq market structure and spread patterns," Journal of Financial Economics, Elsevier, vol. 45(1), pages 61-89, July. [Downloadable!] (restricted)
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