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Upstairs Market for Principal and Agency Trades: Analysis of Adverse Information and Price Effects

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  • Brian F. Smith

Abstract

This paper directly tests the hypothesis that upstairs intermediation lowers adverse selection cost. We find upstairs market makers effectively screen out information-motivated orders and execute large liquidity-motivated orders at a lower cost than the downstairs market. Upstairs markets do not cannibalize or free ride off the downstairs market. In one-quarter of the trades, the upstairs market offers price improvement over the limit orders available in the consolidated limit order book. Trades are more likely to be executed upstairs at times when liquidity is lower in the downstairs market. Copyright The American Finance Association 2001.

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  • Brian F. Smith, 2001. "Upstairs Market for Principal and Agency Trades: Analysis of Adverse Information and Price Effects," Journal of Finance, American Finance Association, vol. 56(5), pages 1723-1746, October.
  • Handle: RePEc:bla:jfinan:v:56:y:2001:i:5:p:1723-1746
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    Cited by:

    1. Jacob A. Bikker & Laura Spierdijk & Pieter Jelle van der Sluis, 2005. "Cheap versus Expensive Trades: Assessing the Determinants of Market Impact Costs," DNB Working Papers 069, Netherlands Central Bank, Research Department.
    2. Ibikunle, Gbenga, 2015. "Opening and closing price efficiency: Do financial markets need the call auction?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 34(C), pages 208-227.
    3. Kwan, Amy & Masulis, Ronald & McInish, Thomas H., 2015. "Trading rules, competition for order flow and market fragmentation," Journal of Financial Economics, Elsevier, vol. 115(2), pages 330-348.
    4. Bessembinder, Hendrik & Venkataraman, Kumar, 2004. "Does an electronic stock exchange need an upstairs market?," Journal of Financial Economics, Elsevier, vol. 73(1), pages 3-36, July.
    5. Henk Berkman & Carole Comertonā€Forde, 2011. "Market microstructure: A review from down under," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 51(1), pages 50-78, March.
    6. Lefebvre, J.J.G., 2011. "Essays on the regulation and microsrtucture of equity markets," Other publications TiSEM c9cdd9ab-6d98-423d-bb8f-b, Tilburg University, School of Economics and Management.
    7. Rose, Annica, 2014. "The informational effect and market quality impact of upstairs trading and fleeting orders on the Australian Securities Exchange," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 171-184.
    8. Luisella Bosetti & Pietro Gottardo & Maurizio Murgia & Andrea Pinna, 2014. "The Impact of Large Orders in Electronic Markets," BEMPS - Bozen Economics & Management Paper Series BEMPS15, Faculty of Economics and Management at the Free University of Bozen.
    9. Katya Malinova & Andreas Park, 2009. "Liquidity, Volume, and Price Behavior: The Impact of Order vs. Quote Based Trading," Working Papers tecipa-358, University of Toronto, Department of Economics.
    10. Bikker, Jacob A. & Spierdijk, Laura & van der Sluis, Pieter Jelle, 2007. "Market impact costs of institutional equity trades," Journal of International Money and Finance, Elsevier, vol. 26(6), pages 974-1000, October.
    11. Vo, Minh T., 2007. "Limit orders and the intraday behavior of market liquidity: Evidence from the Toronto stock exchange," Global Finance Journal, Elsevier, vol. 17(3), pages 379-396, March.
    12. Sylvain Friederich & Richard Payne, 2007. "Dealer Liquidity in an Auction Market: Evidence from the London Stock Exchange," Economic Journal, Royal Economic Society, vol. 117(522), pages 1168-1191, July.
    13. Turnbull, D. Alasdair S. & White, Robert W. & Smith, Brian F., 2010. "In search of liquidity: The block broker's choice of where to trade cross-listed stocks," Journal of Economics and Business, Elsevier, vol. 62(1), pages 20-34, January.
    14. Gomber, Peter & Sagade, Satchit & Theissen, Erik & Weber, Moritz Christian & Westheide, Christian, 2013. "Competition/fragmentation in equities markets: A literature survey," SAFE Working Paper Series 35, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    15. Erik Theissen, 2003. "Trader Anonymity, Price Formation and Liquidity," Review of Finance, European Finance Association, vol. 7(1), pages 1-26.
    16. Frantisek Kopriva, 2008. "Source of Information-Driven Trading on the Prague Stock Exchange," CERGE-EI Working Papers wp365, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    17. Davies, Ryan J., 2003. "The Toronto Stock Exchange preopening session," Journal of Financial Markets, Elsevier, vol. 6(4), pages 491-516, August.

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