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To Trade or Not to Trade: The Effect of Broker Search and Discretionary Trading on Securities Market Performance

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  • Wei Zhang
  • Jinliang Li
  • Chunchi Wu

Abstract

In this article we examine the interaction of brokerage search with the Bayesian learning behavior of competitive dealers under asymmetric information. We particularly focus on the effects of price search and discretionary trading on the performance of a dealer market. A search process is incorporated into a model in which brokers determine their reservation price and whether to continue their trades. The model enables us to uncover the interrelationships among search cost, bid‐ask spread, and price volatility. We show that both spread revision and price volatility are dependent upon the optimal search process, inventory fluctuation, and search cost. Furthermore, our model predicts a negative relationship between price volatility and liquidity trading volume.

Suggested Citation

  • Wei Zhang & Jinliang Li & Chunchi Wu, 2004. "To Trade or Not to Trade: The Effect of Broker Search and Discretionary Trading on Securities Market Performance," The Financial Review, Eastern Finance Association, vol. 39(2), pages 271-292, May.
    • Handle: RePEc:bla:finrev:v:39:y:2004:i:2:p:271-292
    DOI: 10.1111/j.0732-8516.2004.00076.x
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