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The Impact of Adverse Selection on Stock Exchange Specialists’ Price Quotation Strategy

Author

Listed:
  • Kira Muratov-Szabó

    (Corvinus University of Budapest)

  • Kata Váradi

    (Corvinus University of Budapest)

Abstract

This paper focuses on the activity of the specialists – one of the key participants in stock exchange trading. We attempt to model the price quotations of specialists in a modelling framework where some of the parties involved in the transactions may be informed, while others are uninformed “liquidity traders”. It is in this adverse selection modelling framework that, relying on the technique of Monte Carlo simulation, we seek an answer to the following research questions: how does adverse selection impact the price quotation of specialists; to what extent are prices and logreturns influenced by uncertainty; to what degree of accuracy can specialists determine the proportion of informed traders and liquidity traders from trading volumes? Our model confirmed that as soon as uncertainty subsided in the simulated market, the number of transactions, wealth and the stock portfolio started to grow, while price fluctuations began to decline and the standard deviation and the distribution of logreturns edged closer and closer to a normal distribution, which points to improving market efficiency.

Suggested Citation

  • Kira Muratov-Szabó & Kata Váradi, 2019. "The Impact of Adverse Selection on Stock Exchange Specialists’ Price Quotation Strategy," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 18(1), pages 88-124.
    • Handle: RePEc:mnb:finrev:v:18:y:2019:i:1:p:88-124
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    References listed on IDEAS

    as
    1. Kenneth A. Kavajecz, 1999. "A Specialist's Quoted Depth and the Limit Order Book," Journal of Finance, American Finance Association, vol. 54(2), pages 747-771, April.
    2. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    4. Lee, Charles M C & Mucklow, Belinda & Ready, Mark J, 1993. "Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 345-374.
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    More about this item

    Keywords

    specialist; price quotation; adverse selection;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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