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Who makes market

Author

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  • Joon Chae
  • Albert Wang

Abstract

We explore the role of dealers to determine whether they are liquidity-providing market makers or liquidity-taking information traders. Standard models of market making, such as Kyle (1985) and Grossman and Miller (1988), imply a negative contemporaneous correlation between market maker order flow and stock returns. We test this relation with a unique dataset containing trades of all dealers in a well-developed, liquid market. The correlation is strongly positive, implying that dealers take liquidity. We also develop a unique profit decomposition to compare intraweek information and market making profits. Dealers earn significant excess returns, in aggregate driven by information rather than market making. Subgroup analysis reveals that information profits are positive and increasing in stock capitalization, and market making returns are positive and significant for all but the largest stocks

Suggested Citation

  • Joon Chae & Albert Wang, 2004. "Who makes market," Econometric Society 2004 Far Eastern Meetings 605, Econometric Society.
    • Handle: RePEc:ecm:feam04:605
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    References listed on IDEAS

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    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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