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Price Experimentation and Security Market Structure

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Author Info
Chris J. Leach
Ananth N. Madhavan

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Abstract

This paper examines the role of market makers in facilitating price discovery. We show that a specialist may experiment with prices to induce more informative order flow, thereby expediting price discovery. Market makers in a multiple dealer system, unlike a specialist system, do not have the incentives to perform such costly experiments because of free-rider problems. Consequently, the specialist system may provide open markets where competition fails, but at the cost of wider bid-ask spreads. We analyze the effect of experimentation on the bid-ask spread and provide an exploratory analysis of intraday specialist data which is consistent with our price experimentation hypothesis

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Publisher Info
Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 20-92.

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Handle: RePEc:fth:pennfi:20-92

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  1. George J. Mailath & Georg Noldeke, 2007. "Does Competitive Pricing Cause Market Breakdown under Extreme Adverse Selection?," PIER Working Paper Archive 07-022, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
    Other versions:
  2. Charles Goodhart & Takatoshi Ito & Richard Payne, 1995. "One Day in June, 1994: A Study of the Working of Reuters 2000-2 Electronic Foreign Exchange Trading System," NBER Technical Working Papers 0179, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Robert Engle, 1999. "Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market," University of California at San Diego, Economics Working Paper Series 1999-05, Department of Economics, UC San Diego. [Downloadable!]
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  4. Richard K. Lyons, 1993. "Optimal Transparency in a Dealership Market with an Application to Foreign Exchange," NBER Working Papers 4467, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. George J. Mailath & Georg Noldeke, 2006. "Extreme Adverse Selection, Competitive Pricing, and Market Breakdown," Cowles Foundation Discussion Papers 1573, Cowles Foundation, Yale University. [Downloadable!]
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  6. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2005. "The joint dynamics of liquidity, returns, and volatility across small and large firms," Staff Reports 207, Federal Reserve Bank of New York. [Downloadable!]
  7. Alfonso Dufour & Robert Engle, 1999. "Time and the Price Impact of a Trade," University of California at San Diego, Economics Working Paper Series 1999-15, Department of Economics, UC San Diego. [Downloadable!]
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  8. Jan Krahnen & Martin Weber, 2001. "Marketmaking in the Laboratory: Does Competition Matter?," Experimental Economics, Springer, vol. 4(1), pages 55-85, June. [Downloadable!] (restricted)
    Other versions:
  9. Toni Gravelle, 2002. "The Microstructure of Multiple-Dealer Equity and Government Securities Markets: How They Differ," Working Papers 02-9, Bank of Canada. [Downloadable!]
  10. Victoria Saporta & Giorgio Trebeschi & Anne Vila, . "Price formation and transparency on the London Stock Exchange," Bank of England working papers 95, Bank of England. [Downloadable!]
  11. Osler, Carol & Mende, Alexander & Menkhoff, Lukas, 2006. "Price Discovery in Currency Markets," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-351, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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This page was last updated on 2009-11-20.

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