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The Market Structure of Nasdaq Dealer Markets and Quoting Conventions

  • Joe Chen

    (Faculty of Economics, University of Tokyo)

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    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". (JEL L11 G20 C33)

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    File URL: http://www.carf.e.u-tokyo.ac.jp/pdf/workingpaper/fseries/41.pdf
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    Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-040.

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    Length: 52 pages
    Date of creation: Aug 2005
    Date of revision:
    Handle: RePEc:cfi:fseres:cf040
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    17. Kluger, Brian D. & Wyatt, Steve B., 2002. "Preferencing, Internalization of Order Flow, and Tacit Collusion: Evidence from Experiments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(03), pages 449-469, September.
    18. Bloomfield, Robert & O'Hara, Maureen, 1998. "Does order preferencing matter?," Journal of Financial Economics, Elsevier, vol. 50(1), pages 3-37, October.
    19. Huang, Roger D. & Stoll, Hans R., 1996. "Dealer versus auction markets: A paired comparison of execution costs on NASDAQ and the NYSE," Journal of Financial Economics, Elsevier, vol. 41(3), pages 313-357, July.
    20. 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.
    21. Parlour, Christine A. & Rajan, Uday, 2003. "Payment for order flow," Journal of Financial Economics, Elsevier, vol. 68(3), pages 379-411, June.
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    25. Heckman, James J. & Robb, Richard Jr., 1985. "Alternative methods for evaluating the impact of interventions : An overview," Journal of Econometrics, Elsevier, vol. 30(1-2), pages 239-267.
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