Advanced Search
MyIDEAS: Login

Market Making with Costly Monitoring : An Analysis of the SOES Controversy

Contents:

Author Info

  • FOUCAULT, Thierry
  • RÖELL, Ailsa
  • SANDAS, Patrik

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 pick off "stale quotes". Externalities associated with monitoring give rise to multiple equilibria in which dealers earn strictly positive expected profits. We obtain various policy implications. A switch to automatic execution can improve or worsen spreads and price discovery depending on the specific equilibrium. A reduction in the minimum quoted depth tightens the spread but it reduces price efficiency. Our analysis is relevant for the SOES controversy given that speculators in our model behave as the real world SOES "bandits". Our model predicts that SOES bandits should trade in stocks with small spreads and that SOES bandit activity should widen the spread. We provide empirical evidence consistent with these predictions.

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.hec.fr/var/fre/storage/original/application/8de5e66a6dc26bd3c127e464620a7a1d.pdf
Download Restriction: no

Bibliographic Info

Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 702.

as in new window
Length: 52 pages
Date of creation: 01 Apr 2000
Date of revision:
Handle: RePEc:ebg:heccah:0702

Contact details of provider:
Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
Web page: http://www.hec.fr/
More information through EDIRC

Related research

Keywords: Monitoring; bid-ask spread; automatic execution; Soes trading;

Other versions of this item:

Find related papers by JEL classification:

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. Copeland, Thomas E & Galai, Dan, 1983. " Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-69, December.
  2. Dennert, Jurgen, 1993. "Price Competition between Market Makers," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 735-51, July.
  3. Harris, Jeffrey H. & Schultz, Paul H., 1998. "The trading profits of SOES bandits," Journal of Financial Economics, Elsevier, vol. 50(1), pages 39-62, October.
  4. 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.
  5. Kandel, Eugene & M. Marx, Leslie, 1999. "Odd-eighth avoidance as a defense against SOES bandits," Journal of Financial Economics, Elsevier, vol. 51(1), pages 85-102, January.
  6. Kandel, Eugene & Marx, Leslie M., 1997. "Nasdaq market structure and spread patterns," Journal of Financial Economics, Elsevier, vol. 45(1), pages 61-89, July.
  7. 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.
  8. Grossman, Sanford J, et al, 1997. "Clustering and Competition in Asset Markets," Journal of Law and Economics, University of Chicago Press, vol. 40(1), pages 23-60, April.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Foucault, Thierry & Moinas, Sophie & Theissen, Erik, 2003. "Does Anonymity Matter in Electronic Limit Order Markets?," CEPR Discussion Papers 4091, C.E.P.R. Discussion Papers.
  2. Palomino, F.A. & Renneboog, L.D.R. & Zhang, C., 2008. "Information Salience, Investor Sentiment, and Stock Returns: The Case of British Soccer Betting," Discussion Paper 2008-044, Tilburg University, Tilburg Law and Economic Center.
  3. Hendershott, Terrence & Moulton, Pamela C., 2011. "Automation, speed, and stock market quality: The NYSE's Hybrid," Journal of Financial Markets, Elsevier, vol. 14(4), pages 568-604, November.
  4. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May.
  5. Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2013. "High frequency trading and price discovery," Working Paper Series 1602, European Central Bank.
  6. Erenburg, Grigori & Lasser, Dennis, 2009. "Electronic limit order book and order submission choice around macroeconomic news," Review of Financial Economics, Elsevier, vol. 18(4), pages 172-182, October.
  7. Garvey, Ryan & Wu, Fei, 2010. "Speed, distance, and electronic trading: New evidence on why location matters," Journal of Financial Markets, Elsevier, vol. 13(4), pages 367-396, November.
  8. Liu, Wai-Man, 2009. "Monitoring and limit order submission risks," Journal of Financial Markets, Elsevier, vol. 12(1), pages 107-141, February.
  9. Vaihekoski, Mika, 2008. "History of finance research and education in Finland: The first thirty years," Research Discussion Papers 18/2008, Bank of Finland.
  10. Mika Vaihekoski, 2011. "History of financial research and education in Finland," The European Journal of Finance, Taylor & Francis Journals, vol. 17(5-6), pages 339-354.
  11. Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, 02.
  12. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 39855, University Library of Munich, Germany.
  13. Benston, George J. & Wood, Robert A., 2008. "Why effective spreads on NASDAQ were higher than on the New York stock exchange in the 1990s," Journal of Empirical Finance, Elsevier, vol. 15(1), pages 17-40, January.
  14. Fong, Kingsley Y.L. & Liu, Wai-Man, 2010. "Limit order revisions," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1873-1885, August.
  15. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 44621, University Library of Munich, Germany, revised Jan 2013.

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:heccah:0702. 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: (Sandra Dupouy).

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.