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Behavioral heterogeneity and financial markets: Locked/crossed quotes under informationally efficient pricing

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  • Youzong Xu
  • Bo Li

Abstract

Market professionals and regulators have been concerned by locked/crossed quotes (negative quoted spreads) for years. To ease the concerns that locked/crossed quotes may cause confusion or instability in financial markets and to promote market efficiency, the Securities and Exchange Commission implemented rules that ban locked/crossed quotes. We consider a competitive financial market that does not contain the factors considered by market professionals and regulators consider as the origins of locked/crossed quotes. We find that if there are at least three types of traders in this financial market, locked/crossed quotes can arise naturally under efficient pricing. These locked/crossed quotes reflect information transmitted in financial markets, facilitating price discovery. Hence, regulations banning locked/crossed quotes are inappropriate, as these regulations may harm the efficiency of price discovery.

Suggested Citation

  • Youzong Xu & Bo Li, 2017. "Behavioral heterogeneity and financial markets: Locked/crossed quotes under informationally efficient pricing," Cogent Economics & Finance, Taylor & Francis Journals, vol. 5(1), pages 1384524-138, January.
    • Handle: RePEc:taf:oaefxx:v:5:y:2017:i:1:p:1384524
    DOI: 10.1080/23322039.2017.1384524
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