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Preferencing, internalization and inventory position

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Author Info
Lescourret, Laurence () (ESSEC Business School)
Robert, Christian Y. () (Ecole Nationale de la Statistique et de l’Administration Economique (ENSAE))

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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.

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

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

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Related research
Keywords: Internalization; Inventory Control; Market Microstructure; Preferencing; Transparency;

Find related papers by JEL classification:
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm

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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.:
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  27. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Esposito Vinzi, Vincenzo & Ringle, Christian M. & Squillacciotti, Silvia & Trinchera, Laura, 2007. "Capturing and Treating Unobserved Heterogeneity by Response Based Segmentation in PLS Path Modeling. A Comparison of Alternative Methods by Computational Experiments," ESSEC Working Papers DR 07019, ESSEC Research Center, ESSEC Business School. [Downloadable!]
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