IDEAS home Printed from https://ideas.repec.org/p/aah/create/2007-04.html
   My bibliography  Save this paper

Paying for Market Quality

Author

Listed:
  • Amber Anand
  • Carsten Tanggaard
  • Daniel G. Weaver

    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Abstract

Since the affirmative obligations of liquidity providers are costly, electronic markets have struggled with the means of providing compensation to liquidity providers in return for assuming these obligations. This problem is acute for small stocks, which benefit most from the presence of designated liquidity providers. In this study, we examine the 2002 decision by the Stockholm Stock Exchange to allow listed firms to directly negotiate with liquidity suppliers for a desired level of liquidity in exchange for a negotiated fee. We find that benefits accrue to firms that enter into such arrangements in the form of significant improvements in market quality as well as price discovery. Further, we find that a firm’s stock price rises in direct proportion to the improvements in market quality. We study the determinants of the compensation for liquidity provision and document a link between contracted fees and the level of desired liquidity. By examining the trading of liquidity providers we find that their propensity to supply liquidity increases at times of large spreads, and against market movements. Our findings suggest that firms should consider these market quality improvement opportunities as they do other capital budgeting decisions, especially in light of the positive externalities that we find accrue to the liquidity of the firms’ stocks.

Suggested Citation

  • 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.
  • Handle: RePEc:aah:create:2007-04
    as

    Download full text from publisher

    File URL: https://repec.econ.au.dk/repec/creates/rp/07/rp07_04.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. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1996. "Market microstructure and asset pricing: On the compensation for illiquidity in stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 441-464, July.
    3. Sanford J. Grossman & Merton H. Miller, 1988. "Liquidity and Market Structure," NBER Working Papers 2641, National Bureau of Economic Research, Inc.
    4. Glosten, Lawrence R, 1994. "Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-1161, September.
    5. Glosten, Lawrence R, 1989. "Insider Trading, Liquidity, and the Role of the Monopolist Specialist," The Journal of Business, University of Chicago Press, vol. 62(2), pages 211-235, April.
    6. 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.
    7. Nimalendran, M. & Petrella, Giovanni, 2003. "Do 'thinly-traded' stocks benefit from specialist intervention?," Journal of Banking & Finance, Elsevier, vol. 27(9), pages 1823-1854, September.
    8. Heckman, James J, 1978. "Dummy Endogenous Variables in a Simultaneous Equation System," Econometrica, Econometric Society, vol. 46(4), pages 931-959, July.
    9. repec:bla:jfinan:v:43:y:1988:i:3:p:617-37 is not listed on IDEAS
    10. Bessembinder, Hendrik, 1999. "Trade Execution Costs on NASDAQ and the NYSE: A Post-Reform Comparison," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(3), pages 387-407, September.
    11. 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.
    12. Neal, Robert, 1992. "A Comparison of Transaction Costs between Competitive Market Maker and Specialist Market Structures," The Journal of Business, University of Chicago Press, vol. 65(3), pages 317-334, July.
    13. Madhavan, Ananth & Sofianos, George, 1998. "An empirical analysis of NYSE specialist trading," Journal of Financial Economics, Elsevier, vol. 48(2), pages 189-210, May.
    14. Lesmond, David A., 2005. "Liquidity of emerging markets," Journal of Financial Economics, Elsevier, vol. 77(2), pages 411-452, August.
    15. Madhavan, Ananth & Panchapagesan, Venkatesh, 2000. "Price Discovery in Auction Markets: A Look Inside the Black Box," The Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 627-658.
    16. 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.
    17. Anand, Amber & Weaver, Daniel G., 2006. "The value of the specialist: Empirical evidence from the CBOE," Journal of Financial Markets, Elsevier, vol. 9(2), pages 100-118, May.
    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. Anand, Amber & Chakravarty, Sugato & Chuwonganant, Chairat, 2009. "Cleaning house: Stock reassignments on the NYSE," Journal of Financial Markets, Elsevier, vol. 12(4), pages 727-753, November.
    2. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    3. repec:uts:finphd:34 is not listed on IDEAS
    4. Nimalendran, M. & Petrella, Giovanni, 2003. "Do 'thinly-traded' stocks benefit from specialist intervention?," Journal of Banking & Finance, Elsevier, vol. 27(9), pages 1823-1854, September.
    5. Murphy Jun Jie Lee, 2013. "The Microstructure of Trading Processes on the Singapore Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 4, July-Dece.
    6. 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.
    7. Murphy Jun Jie Lee, 2013. "The Microstructure of Trading Processes on the Singapore Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 2-2013, January-A.
    8. 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.
    9. 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.
    10. Jagjeev Dosanjh, 2017. "Exchange Initiatives and Market Efficiency: Evidence from the Australian Securities Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2017, January-A.
    11. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity -- Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
    12. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
    13. Frino, Alex & Gerace, Dionigi & Lepone, Andrew, 2008. "Liquidity in auction and specialist market structures: Evidence from the Italian bourse," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2581-2588, December.
    14. Hung‐Neng Lai, 2007. "The Market Quality of Dealer versus Hybrid Markets: The Case of Moderately Liquid Securities," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(1‐2), pages 349-373, January.
    15. Dumitrescu, Ariadna, 2010. "The strategic specialist and imperfect competition in a limit order market," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 255-266, January.
    16. Louis K. C. Chan & Josef Lakonishok, 1995. "A Cross-Market Comparison of Institutional Equity Trading Costs," NBER Working Papers 5374, National Bureau of Economic Research, Inc.
    17. Anand, Amber & Weaver, Daniel G., 2006. "The value of the specialist: Empirical evidence from the CBOE," Journal of Financial Markets, Elsevier, vol. 9(2), pages 100-118, May.
    18. Chung, Kee H. & Van Ness, Bonnie F. & Van Ness, Robert A., 1999. "Limit orders and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 53(2), pages 255-287, August.
    19. Díaz, Antonio & Escribano, Ana, 2022. "Liquidity dimensions in the U.S. corporate bond market," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 1163-1179.
    20. Laurence Lescourret, 2017. "Cold Case File? Inventory Risk and Information Sharing during the pre†1997 NASDAQ," European Financial Management, European Financial Management Association, vol. 23(4), pages 761-806, September.
    21. Bacidore, Jeffrey M. & Sofianos, George, 2002. "Liquidity provision and specialist trading in NYSE-listed non-U.S. stocks," Journal of Financial Economics, Elsevier, vol. 63(1), pages 133-158, January.

    More about this item

    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:aah:create:2007-04. See general information about how to correct material in RePEc.

    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: the person in charge (email available below). General contact details of provider: http://www.econ.au.dk/afn/ .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.