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The Market Structure of Nasdaq Dealer Markets and Quoting Conventions

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  • Joe Chen

    (Faculty of Economics, University of Tokyo)

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    Abstract

    The well-publicized Christie-Schultz collusion hypothesis provides an experiment for studying the determinants of market structure in Nasdaq markets. Some markets experienced substantial compression in the profit margins for market makers due to the change of quoting convention from odd-eighth avoidance to the use of the full spectrum of eighths. Contrary to what competitive theory predicts, the empirical results suggest that this change led to net entry of market makers, after controlling for a time fixed effect, trading activity, information aspects of trading, market size, volatility, and unobserved individual market effects. Moreover, the robustness and significance of this finding do not change as different estimation methods are employed to correct for possible self-selection bias of the estimated average treatment effect. Surprisingly, dealer firms entered these markets despite the compression of profit margins. An explanation is provided based on collusion and investment in entry deterrence related to the practice of ``preferencing".

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2005/2005cf357.pdf
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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-357.

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    Length: 52 pages
    Date of creation: Aug 2005
    Date of revision:
    Handle: RePEc:tky:fseres:2005cf357

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    1. James P. Weston, 2000. "Competition on the Nasdaq and the Impact of Recent Market Reforms," Journal of Finance, American Finance Association, vol. 55(6), pages 2565-2598, December.
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    6. Goldstein, Michael A & Nelling, Edward F, 1999. "Market Making and Trading in Nasdaq Stocks," The Financial Review, Eastern Finance Association, vol. 34(1), pages 27-44, February.
    7. Christie, William G. & Schultz, Paul H., 1999. "The initiation and withdrawal of odd-eighth quotes among Nasdaq stocks: an empirical analysis," Journal of Financial Economics, Elsevier, vol. 52(3), pages 409-442, June.
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    21. Christie, William G & Schultz, Paul H, 1994. " Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1813-40, December.
    22. Christie, William G & Harris, Jeffrey H & Schultz, Paul H, 1994. " Why Did NASDAQ Market Makers Stop Avoiding Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1841-60, December.
    23. Parlour, Christine A. & Rajan, Uday, 2003. "Payment for order flow," Journal of Financial Economics, Elsevier, vol. 68(3), pages 379-411, June.
    24. Wahal, Sunil, 1997. "Entry, Exit, Market Makers, and the Bid-Ask Spread," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 871-901.
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