NASDAQ Market Structure and Spreads Patterns PDF Download

Author: Eugene Kandel
Publisher:
ISBN:
Category :
Languages : en
Pages :

Get Book Here

Book Description
This paper argues that the standard competitive equilibrium result that prices will be driven down to the level of marginal cost cannot be routinely applied to the NASDAQ market without explicitly taking into account the institutional features of this market. We show that price competition among a large number of liquidity-providing dealers does not necessarily reduce spreads below the marginal cost of trading plus twice the exogenously set minimum tick size. We also discuss the existing explanations for the phenomenon of the odd-eighths avoidance documented in Christie and Schultz (1994) and provide an alternative explanation based on the concept of focal-point equilibria. The proposed explanation does not rule out the possibility of overt collusion, but shows that a simple coordination device may allow market makers to select the largest competitive equilibrium spread and thus attain profits similar to those possible with a formal collusive arrangement. We show that a different coordination device may be required for low-priced stocks because of their smaller tick size. Finally, we examine one month of data on NASDAQ quotes to illustrate the ideas of the paper. In particular we show that the frequency of odd-eighths avoidance increases dramatically as the minimum tick size declines. We also document that in our sample complete odd-eighths quotes avoidance tends to significantly increase the spread for otherwise comparable stocks.