IDEAS home Printed from https://ideas.repec.org/p/hhb/aarbfi/2006-06.html
   My bibliography  Save this paper

Paying for Market Quality

Author

Listed:
  • Anand, Amber

    (School of Management)

  • Tanggaard, Carsten

    (Department of Business Studies, Aarhus School of Business)

  • Weaver, Daniel G.

    (Department of Finance)

Abstract

One way to improve the liquidity of small stocks is to subsidize the providers of liquidity. These subsidies take many forms such as informational advantages, priority in trading with incoming order flow, and fee rebates for limit order traders. In this study, we examine another type of subsidy – directly paying liquidity providers to provide contractual improvement in liquidity. Our specific focus here is the 2002 decision by the Stockholm Stock Exchange to allow listed firms to negotiate with liquidity providers to set maximum spread widths and minimum depths. We find, for a sample of stocks that entered into such an arrangement, a significant improvement in market quality with a decline in quoted spreads and an increase in quoted depth throughout the limit order book. We also find evidence that suggests that there are improvements beyond those contracted for. In addition, both inter and intraday volatility decline following the entry of committed liquidity providers for these stocks. Traders benefit by the reduced costs as well as by the ease of finding liquidity as seen in the increased trade sizes. We also find that a firm’s stock price subsequent to entering into the agreement rises in direct proportion to the improvement in market quality Thus, we find overwhelming evidence of liquidity benefits to listed firms of entering into such contracts which suggests that firms should consider these market quality improvement opportunities as they do other capital budgeting decisions and that there are residual benefits beyond those contracted for.

Suggested Citation

  • Anand, Amber & Tanggaard, Carsten & Weaver, Daniel G., 2005. "Paying for Market Quality," Finance Research Group Working Papers F-2006-06, University of Aarhus, Aarhus School of Business, Department of Business Studies.
  • Handle: RePEc:hhb:aarbfi:2006-06
    as

    Download full text from publisher

    File URL: http://www.hha.dk/bs/wp/fin/F_2006_06.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
    2. Madhavan, Ananth & Smidt, Seymour, 1993. "An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
    3. Grossman, Sanford J & Miller, Merton H, 1988. " Liquidity and Market Structure," Journal of Finance, American Finance Association, vol. 43(3), pages 617-637, July.
    4. Marios Panayides & Andreas Charitou, 2004. "The Role of the Market Maker in International Capital Markets: Challenges and Benefits of Implementation in Emerging Markets," Yale School of Management Working Papers ysm443, Yale School of Management.
    5. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    6. Christine A. Parlour & Duane J. Seppi, 2003. "Liquidity-Based Competition for Order Flow," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 301-343.
    7. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    8. Madhavan, Ananth & Sofianos, George, 1998. "An empirical analysis of NYSE specialist trading," Journal of Financial Economics, Elsevier, vol. 48(2), pages 189-210, May.
    9. Madhavan, Ananth & Panchapagesan, Venkatesh, 2000. "Price Discovery in Auction Markets: A Look Inside the Black Box," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 627-658.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Turan G. Bali & Robert F. Engle & Yi Tang, 2017. "Dynamic Conditional Beta Is Alive and Well in the Cross Section of Daily Stock Returns," Management Science, INFORMS, vol. 63(11), pages 3760-3779, November.
    2. Hendershott, Terrence & Menkveld, Albert J., 2014. "Price pressures," Journal of Financial Economics, Elsevier, vol. 114(3), pages 405-423.
    3. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    4. Subrahmanyam, Avanidhar, 2009. "The implications of liquidity and order flows for neoclassical finance," Pacific-Basin Finance Journal, Elsevier, vol. 17(5), pages 527-532, November.
    5. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    6. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May.
    7. Amber Anand & Carsten Tanggaard & Daniel G. Weaver, 2007. "Paying for Market Quality," CREATES Research Papers 2007-04, Department of Economics and Business Economics, Aarhus University.
    8. Hendershott, Terrence & Seasholes, Mark S., 2014. "Liquidity provision and stock return predictability," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 140-151.
    9. Lang, Mark & Maffett, Mark, 2011. "Transparency and liquidity uncertainty in crisis periods," Journal of Accounting and Economics, Elsevier, vol. 52(2), pages 101-125.
    10. De Moor, Lieven & Sercu, Piet, 2013. "The smallest firm effect: An international study," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 129-155.
    11. Péter Kondor & Dimitri Vayanos, 2019. "Liquidity Risk and the Dynamics of Arbitrage Capital," Journal of Finance, American Finance Association, vol. 74(3), pages 1139-1173, June.
    12. Abankwa, Samuel & Blenman, Lloyd P., 2021. "Measuring liquidity risk effects on carry trades across currencies and regimes," Journal of Multinational Financial Management, Elsevier, vol. 60(C).
    13. Qingjing Zhang & Taufiq Choudhry & Jing-Ming Kuo & Xiaoquan Liu, 2021. "Does liquidity drive stock market returns? The role of investor risk aversion," Review of Quantitative Finance and Accounting, Springer, vol. 57(3), pages 929-958, October.
    14. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity -- Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
    15. Hearn, Bruce, 2010. "Time varying size and liquidity effects in South Asian equity markets: A study of blue-chip industry stocks," International Review of Financial Analysis, Elsevier, vol. 19(4), pages 242-257, September.
    16. Kehr, Carl-Heinrich & Krahnen, Jan P. & Theissen, Erik, 2001. "The Anatomy of a Call Market," Journal of Financial Intermediation, Elsevier, vol. 10(3-4), pages 249-270, July.
    17. Zhang, Wei & Huang, Ke & Feng, Xu & Zhang, Yongjie, 2017. "Market maker competition and price efficiency: Evidence from China," Economic Modelling, Elsevier, vol. 66(C), pages 121-131.
    18. Cao, Charles & Chen, Yong & Liang, Bing & Lo, Andrew W., 2013. "Can hedge funds time market liquidity?," Journal of Financial Economics, Elsevier, vol. 109(2), pages 493-516.
    19. Vayanos, Dimitri & Wang, Jiang, 2009. "Liquidity and asset prices: a united framework," LSE Research Online Documents on Economics 29303, London School of Economics and Political Science, LSE Library.
    20. Cebiroglu, Gökhan & Hautsch, Nikolaus & Walsh, Christopher, 2019. "Revisiting the stealth trading hypothesis: Does time-varying liquidity explain the size-effect?," CFS Working Paper Series 625, Center for Financial Studies (CFS).

    More about this item

    Keywords

    No keywords;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhb:aarbfi:2006-06. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/ifhhadk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Helle Vinbaek Stenholt The email address of this maintainer does not seem to be valid anymore. Please ask Helle Vinbaek Stenholt to update the entry or send us the correct address (email available below). General contact details of provider: https://edirc.repec.org/data/ifhhadk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.