Advanced Search
MyIDEAS: Login to save this paper or follow this series

Preferencing, internalization and inventory position

Contents:

Author Info

  • Lescourret, Laurence

    ()
    (ESSEC Business School)

  • Robert, Christian Y.

    ()
    (Ecole Nationale de la Statistique et de l’Administration Economique (ENSAE))

Abstract

We present a model of market-making in which dealers differ by their current inventory positions and by their preferencing agreements. Under preferencing, dealers receive captive orders that they guarantee to execute at the best price. We show that preferencing raises the inventory holding costs of preferenced dealers. In turn, competitors post less aggressive quotes. Since price-competition is softened, expected spreads widen. The entry of unpreferenced dealers, or the ability to route preferenced orders to best-quoting dealers, as internalization does restore price competitiveness. We also show that a greater transparency may negatively affect expected spreads, depending on the scale of preferencing.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.essec.fr/faculty/showDeclFileRes.do?declId=6628&key=__workpaper__
Download Restriction: no

Bibliographic Info

Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 06017.

as in new window
Length: 49 pages
Date of creation: Nov 2006
Date of revision:
Handle: RePEc:ebg:essewp:dr-06017

Contact details of provider:
Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
Email:
Web page: http://www.essec.edu/
More information through EDIRC

Related research

Keywords: Internalization; Inventory Control; Market Microstructure; Preferencing; Transparency;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Estelle Cantillon, 2008. "The effect of bidders' asymmetries on expected revenue in auctions," ULB Institutional Repository 2013/9001, ULB -- Universite Libre de Bruxelles.
  2. Madhavan, Ananth & Smidt, Seymour, 1993. " An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
  3. Thomas Ho & Hans Stoll, . "Optimal Dealer Pricing Under Transactions and Return Uncertainty," Rodney L. White Center for Financial Research Working Papers 27-79, Wharton School Rodney L. White Center for Financial Research.
  4. Matthew Rhodes-Kropf, 2005. "Price Improvement in Dealership Markets," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1137-1172, July.
  5. Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," SIFR Research Report Series 17, Institute for Financial Research.
  6. Dutta, Prajit K & Madhavan, Ananth, 1997. " Competition and Collusion in Dealer Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 245-76, March.
  7. Richard K. Lyons., 1993. "Tests of Microstructural Hypotheses in the Foreign Exchange Market," Research Program in Finance Working Papers RPF-230, University of California at Berkeley.
  8. Biais, Bruno, 1993. " Price Information and Equilibrium Liquidity in Fragmented and Centralized Markets," Journal of Finance, American Finance Association, vol. 48(1), pages 157-85, March.
  9. Godek, Paul E., 1996. "Why Nasdaq market makers avoid odd-eighth quotes," Journal of Financial Economics, Elsevier, vol. 41(3), pages 465-474, July.
  10. Lebrun, Bernard, 1999. "First Price Auctions in the Asymmetric N Bidder Case," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(1), pages 125-42, February.
  11. Maskin, Eric & Riley, John, 2000. "Asymmetric Auctions," Review of Economic Studies, Wiley Blackwell, vol. 67(3), pages 413-38, July.
  12. Madhavan, Ananth & Sofianos, George, 1998. "An empirical analysis of NYSE specialist trading," Journal of Financial Economics, Elsevier, vol. 48(2), pages 189-210, May.
  13. repec:wop:humbsf:2000-72 is not listed on IDEAS
  14. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1996. " Cream-Skimming or Profit-Sharing? The Curious Role of Purchased Order Flow," Journal of Finance, American Finance Association, vol. 51(3), pages 811-33, July.
  15. He, Chen & Odders-White, Elizabeth & Ready, Mark J., 2006. "The impact of preferencing on execution quality," Journal of Financial Markets, Elsevier, vol. 9(3), pages 246-273, August.
  16. Peter C. Reiss & Ingrid M. Werner, 1998. "Does Risk Sharing Motivate Interdealer Trading?," Journal of Finance, American Finance Association, vol. 53(5), pages 1657-1703, October.
  17. Kandel, Eugene & Marx, Leslie M., 1997. "Nasdaq market structure and spread patterns," Journal of Financial Economics, Elsevier, vol. 45(1), pages 61-89, July.
  18. Bloomfield, Robert & O'Hara, Maureen, 1998. "Does order preferencing matter?," Journal of Financial Economics, Elsevier, vol. 50(1), pages 3-37, October.
  19. Mark Klock, 2002. "The Effect of Market Structure on the Incentives to Quote Aggressively: An Empirical Study of Nasdaq Market Makers," The Financial Review, Eastern Finance Association, vol. 37(3), pages 403-419, 08.
  20. Oliver Hansch & Narayan Y. Naik & S. Viswanathan, 1998. "Do Inventories Matter in Dealership Markets? Evidence from the London Stock Exchange," Journal of Finance, American Finance Association, vol. 53(5), pages 1623-1656, October.
  21. Chakravarty, Sugato & Sarkar, Asani, 2002. "A model of broker's trading, with applications to order flow internalization," Review of Financial Economics, Elsevier, vol. 11(1), pages 19-36.
  22. Chung, Kee H. & Chuwonganant, Chairat & McCormick, D. Timothy, 2006. "Does internalization diminish the impact of quote aggressiveness on dealer market share?," Journal of Financial Intermediation, Elsevier, vol. 15(1), pages 108-131, January.
  23. Yusif Simaan & Daniel G. Weaver & David K. Whitcomb, 2003. "Market Maker Quotation Behavior and Pretrade Transparency," Journal of Finance, American Finance Association, vol. 58(3), pages 1247-1268, 06.
  24. Christine A. Parlour & Duane J. Seppi, 2003. "Liquidity-Based Competition for Order Flow," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 301-343.
  25. Bloomfield, Robert & O'Hara, Maureen, 1999. "Market Transparency: Who Wins and Who Loses?," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 5-35.
  26. Oliver Hansch & Narayan Y. Naik & S. Viswanathan, 1999. "Preferencing, Internalization, Best Execution, and Dealer Profits," Journal of Finance, American Finance Association, vol. 54(5), pages 1799-1828, October.
  27. Eugene Kandel & Leslie M. Marx, 1999. "Payments for Order Flow on Nasdaq," Journal of Finance, American Finance Association, vol. 54(1), pages 35-66, 02.
  28. Chung, Kee H. & Chuwonganant, Chairat & McCormick, D. Timothy, 2004. "Order preferencing and market quality on NASDAQ before and after decimalization," Journal of Financial Economics, Elsevier, vol. 71(3), pages 581-612, March.
  29. Marshall Robert C. & Meurer Michael J. & Richard Jean-Francois & Stromquist Walter, 1994. "Numerical Analysis of Asymmetric First Price Auctions," Games and Economic Behavior, Elsevier, vol. 7(2), pages 193-220, September.
  30. Huang, Roger D. & Stoll, Hans R., 1996. "Dealer versus auction markets: A paired comparison of execution costs on NASDAQ and the NYSE," Journal of Financial Economics, Elsevier, vol. 41(3), pages 313-357, July.
  31. M. Ángeles de Frutos & Carolina Manzano, 2002. "Risk Aversion, Transparency, and Market Performance," Journal of Finance, American Finance Association, vol. 57(2), pages 959-984, 04.
  32. Ho, Thomas S Y & Stoll, Hans R, 1983. " The Dynamics of Dealer Markets under Competition," Journal of Finance, American Finance Association, vol. 38(4), pages 1053-74, September.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:ebg:essewp:dr-06017. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sophie Magnanou).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.