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Preferencing, Internalization of Order Flow, and Tacit Collusion: Evidence from Experiments

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  • Kluger, Brian D.
  • Wyatt, Steve B.

Abstract

This paper examines preferencing arrangements and tacit collusion in laboratory asset markets. In the experiments, dealers may internalize by matching the best quote or by passing orders to the dealer posting the best quote. Although some markets were highly competitive, several markets reached a collusive equilibrium with wide spreads and near complete internalization of order flow. The paper further examines the role of market transparency and passed order flow on quote-setting behavior and suggests that these affect the mechanism leading to tacitly collusive equilibria.

Suggested Citation

  • 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(3), pages 449-469, September.
    • Handle: RePEc:cup:jfinqa:v:37:y:2002:i:03:p:449-469_00
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    Citations

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    Cited by:

    1. Joe Chen, 2005. "The Market Structure of Nasdaq Dealer Markets and Quoting Conventions," CARF F-Series CARF-F-040, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    2. Chung, Kee H. & Chuwonganant, Chairat & McCormick, D. Timothy, 2006. "Does internalization diminish the impact of quote aggressiveness on dealer market share?," Journal of Financial Intermediation, Elsevier, vol. 15(1), pages 108-131, January.
    3. Helbing, Dirk & Balietti, Stefano, 2011. "Big data, privacy, and trusted web: What needs to be done," MPRA Paper 49702, University Library of Munich, Germany.
    4. Joe Chen, 2005. "The Market Structure of Nasdaq Dealer Markets and Quoting Conventions," CIRJE F-Series CIRJE-F-357, CIRJE, Faculty of Economics, University of Tokyo.
    5. Jacob Thomas & Frank Zhang & Wei Zhu, 2021. "Dark Trading and Post-Earnings-Announcement Drift," Management Science, INFORMS, vol. 67(12), pages 7785-7811, December.
    6. Chung, Kee H. & Chuwonganant, Chairat & McCormick, D. Timothy, 2004. "Order preferencing and market quality on NASDAQ before and after decimalization," Journal of Financial Economics, Elsevier, vol. 71(3), pages 581-612, March.
    7. Atanasov, Vladimir & Davies, Ryan J. & Merrick, John J., 2015. "Financial intermediaries in the midst of market manipulation: Did they protect the fool or help the knave?," Journal of Corporate Finance, Elsevier, vol. 34(C), pages 210-234.
    8. Lescourret, Laurence & Robert, Christian Y., 2011. "Transparency matters: Price formation in the presence of order preferencing," Journal of Financial Markets, Elsevier, vol. 14(2), pages 227-258, May.
    9. Norris L. Larrymore & Albert J. Murphy, 2009. "Internalization And Market Quality: An Empirical Investigation," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 32(3), pages 337-363, September.
    10. S. Ghon Rhee & Ning Tang, 2013. "Can quote competition reduce preferenced trading? A reexamination of the SEC’s 1997 order handling rules," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(1), pages 243-264, March.

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