Information shares in a two-tier FX market

Using several measures of information share, we examine price discovery across the inter-dealer and dealer–customer market tiers in the currencies market. In the spot market, the information share of the inter-dealer tier is higher than that of the dealer–customer one for non-financial sector trades and is lower than the dealer–customer tier for foreign investors’ sell trades. In the forward market, the dealer–customer tier generally has the greater information share at the dealer’s buy side. Our results indicate the market where customers’ trades are the most informative and demonstrate how exogenous events affect price discovery across markets and market tiers.     

Financial intermediation and the role of price discrimination in the foreign exchange market

Foreign exchange trading is performed in opaque and decentralized markets. The two-tier market structure consisting of a customer segment and an interdealer segment to which only market makers have access gives rise to the possibility of price discrimination. We develop a theoretical pricing model that accounts for market-power considerations and analyze a database of the trades of a foreign exchange market maker. We find that the market maker generally exerts low bargaining power vis-á-vis customers. The dealer earns lower average spreads on trades with financial customers than commercial customers, even though the former are perceived to convey exchange-rate-relevant information.     

Interest rate variability,government securities dealers,and the stability of financial markets

Monetarists argue that monetary policy should focus on controlling monetary growth rather than interest rates. Arguments to smooth rates at the expense of stabilizing monetary growth frequently emphasize the adverse effects of rate variability on financial markets. Assuming that financial market performance can be correctly inferred from dealer positions and spreads, this paper estimates the parameters of a model that allows for both short- and long-term effects of rate variability on dealer positions and spreads. Estimates of variability effects on government securities dealer positions and spreads provide little support for limiting variability to maintain or improve market performance because most of the adverse effects of variability are temporary.     

The Components of Electronic Inter-Dealer Spot FX Bid-Ask Spreads

Abstract:  This paper applies an established bid-ask spread decomposition model to the inter-dealer spot foreign exchange market. In addition, the paper presents and tests a modified decomposition model which is specifically adapted to the features of order-driven markets and which is found to produce more plausible results than the original model. Price clustering is introduced as a new explanatory factor within this framework and is shown to be vitally important in understanding the composition of bid-ask spreads in this market.     

Market structure and bid-ask spreads: IBIS vs Nasdaq

A comparison is made between the bid-ask spreads of 30 high volume German stocks traded on IBIS and 30 high volume US stocks traded on Nasdaq. IBIS and Nasdaq are best described as agency and dealer auction markets, respectively. On average, the market spread for these IBIS and Nasdaq stocks is the same, but for the 10 most active stocks in each market, IBIS spreads are considerably lower. For these latter stocks, IBIS spreads change in a predictable manner throughout the day. Nasdaq spreads do not. The critical factor appears to be the unrestricted access of suppliers of immediacy that is distinctive for agency auction markets.     

The role of private information in return volatility,bid–ask spreads and price levels in the foreign exchange market

Trading volume and order flow have both been closely associated with informed trader activity in the market microstructure literature. Using theory that explains regular intraday patterns in trading data, we transform these two variables into proxies for private information and examine their relationships with bid–ask spreads and return volatility. We use a unique and unusually rich high-frequency intraday dataset from the world's largest financial market, namely, the electronic inter-dealer spot foreign exchange market. Our analysis takes account of institutional features peculiar to this order-driven market. Our empirical results strongly affirm our theoretical understanding of how these markets work. They also reveal how the structure of the inter-dealer spot FX market affects exchange rate volatility. Finally, we also explore how private information contributes to the evolution of prices.     

Two months in the life of several gilt-edged market makers on the London Stock Exchange

We investigate the micro structure of the UK gilt market studying the behaviour of several gilt-edged market makers on the London Stock Exchange. Through a structural model of the price process we can test different microstructural hypotheses, concerning information asymmetries, transaction and inventory carrying costs, and market liquidity. Our results suggest that inventories do not alter the price process in the gilt market. Moreover, in contrast to customer orders, inter-dealer transactions possess an information content. Transaction costs in the inter-dealer market are also substantially smaller than those for external customers.     

THE DEALER AND MARKET CONCEPTS OF BID-ASK SPREAD: A COMPARISON FOR NASDAQ STOCKS

Two models of bid-ask spread are estimated with a unique sample of matched observations of dealer spreads and market (inside) spreads for NASDAQ stocks. The estimates demonstrate that dealer and market spreads relate differently to their common determinants, indicating that the two measures are not interchangeable. Consequently, studies must select the spread concept that is appropriate to the hypothesis being tested to get unbiased estimates and correct interpretations of model parameters. In particular, the cost of immediacy to investors is measured directly by market spreads, while market-making costs and interdealer competition relate directly to dealer spreads.     

The Quality of ECN and Nasdaq Market Maker Quotes

This paper compares the quality of quotes submitted by electronic communication networks (ECNs) and by traditional market makers to the Nasdaq quote montage. An analysis of the most active Nasdaq stocks shows that ECNs not only post informative quotes, but also, compared to market makers, ECNs post quotes rapidly and are more often at the inside. Additionally, ECN quoted spreads are smaller than dealer quoted spreads. The evidence suggests that the proliferation of alternative trading venues, such as ECNs, may promote quote quality rather than fragmenting markets. Moreover, the results suggest that a more open book contributes to quote quality.     

Capital Commitment and Illiquidity in Corporate Bonds

We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, average trade execution costs have not increased notably over time. However, dealer capital commitment, turnover, block trade frequency, and average trade size decreased during the financial crisis and thereafter. These declines are attributable to bank‐affiliated dealers, as nonbank dealers have increased their market commitment. Our evidence indicates that liquidity provision in the corporate bond markets is evolving away from the commitment of bank‐affiliated dealer capital to absorb customer imbalances, and that postcrisis banking regulations likely contribute.     

The impact of central clearing on counterparty risk,liquidity, and trading: Evidence from the credit default swap market

This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than settlement spreads published by the central clearinghouse. Furthermore, the relation between CDS spreads and dealer credit risk weakens after central clearing begins, suggesting a lowering of systemic risk. These findings are robust to controls for frictions in both CDS and bond markets. Finally, matched sample analysis reveals that the increased post-trade transparency following central clearing is associated with an improvement in liquidity and trading activity.     

Information asymmetry and accounting restatement: NYSE-AMEX and NASDAQ evidence

We examine the impact of accounting restatement announcement on firms’ value and information asymmetry for both auction market (NYSE-AMEX) and dealer market (NASDAQ) using a public sample of restatement announcements from 1997 to 2005. In both markets, we document economically and significantly negative mean cumulative abnormal returns around the announcement dates. The restatements attributed to auditors are associated with more negative returns than those attributed to management and the SEC. However, there is no significant difference between market reactions arising from the core and non-core restatements. We also find a significant increase in volume, number of transactions, average order size, volatility, and various measures of spreads after the restatement announcement indicating that restatement announcements diminish company prospects and contribute to increased uncertainty and information asymmetry. Finally, we find that the information asymmetry in the NASDAQ market around the event date is less pronounced than in the NYSE-AMEX market.     

A Comparison of Centralized and Fragmented Markets with Costly Search

How does quotation transparency affect financial market performance? Biais's irrelevance proposition in 1993 shows that centralized markets yield the same expected bid–ask spreads as fragmented markets, other things equal. However, de Frutos and Manzano demonstrated in 2002 that expected spreads in fragmented markets are smaller and market participants prefer to trade in fragmented markets. This paper introduces liquidity traders' costs of searching for a better quote into the Biais model and derives opposite conclusions to these previous studies: expected spreads in centralized markets are smaller and liquidity traders prefer centralized markets, while market makers prefer fragmented markets.     

A learning market-maker in the Glosten–Milgrom model

This paper develops a model of a learning market-maker by extending the Glosten–Milgrom model of dealer markets. The market-maker tracks the changing true value of a stock in settings with informed traders (with noisy signals) and liquidity traders, and sets bid and ask prices based on its estimate of the true value. We empirically evaluate the performance of the market-maker in markets with different parameter values to demonstrate the effectiveness of the algorithm, and then use the algorithm to derive properties of price processes in simulated markets. When the true value is governed by a jump process, there is a two regime behaviour marked by significant heterogeneity of information and large spreads immediately following a price jump, which is quickly resolved by the market-maker, leading to a rapid return to homogeneity of information and small spreads. We also discuss the similarities and differences between our model and real stock market data in terms of distributional and time series properties of returns.     

The relationship between bid–ask spreads and holding periods: The case of Chinese A and B shares

The Chinese stock markets for A (domestic) shares and B (foreign) shares were completely separated. This study examines the relationship between spreads and holding periods across these segmented markets on the same set of firms. Our major findings are as follows. (1) There is a positive relationship between holding periods and bid–ask spreads in the Chinese stock market. (2) Investors' sensitivity toward liquidity is approximately the same in the A and B share markets, even though bid–ask spreads are substantially different across the two markets. These results provide strong support for the theoretical argument of Amihud and Mendelson [Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid–ask spread. Journal of Financial Economics, 17, 223–249.] that stocks with higher spreads tend to be held by long-term investors. Evidence also suggests that liquidity has a role in explaining the B share discount, although the results are less than conclusive.     

The relationship between bid–ask spreads and holding periods: The case of Chinese A and B shares

The Chinese stock markets for A (domestic) shares and B (foreign) shares were completely separated. This study examines the relationship between spreads and holding periods across these segmented markets on the same set of firms. Our major findings are as follows. (1) There is a positive relationship between holding periods and bid–ask spreads in the Chinese stock market. (2) Investors' sensitivity toward liquidity is approximately the same in the A and B share markets, even though bid–ask spreads are substantially different across the two markets. These results provide strong support for the theoretical argument of Amihud and Mendelson [Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid–ask spread. Journal of Financial Economics, 17, 223–249.] that stocks with higher spreads tend to be held by long-term investors. Evidence also suggests that liquidity has a role in explaining the B share discount, although the results are less than conclusive.     

Market structure, informational efficiency and liquidity: An experimental comparison of auction and dealer markets

We report the results of 18 market experiments that were conducted in order to compare the call market, the continuous auction and the dealer market. Transaction prices in the call and continuous auction markets are much more efficient than prices in the dealer markets. The call market shows a tendency towards underreaction to new information. Execution costs are lowest in the call market and highest in the dealer market. The trading volume and Roll's (Journal of Finance (1984) 1127–1139) serial covariance estimator are inappropriate measures of execution costs in the present context. The relation between private signals, trading decisions and trading profits is analyzed.     

Liquidity in auction and specialist market structures: Evidence from the Italian bourse

Several studies find that bid-ask spreads for stocks listed on the NYSE are lower than for stocks listed on NASDAQ. While this suggests that specialist market structures provide greater liquidity than competing dealer markets, the nature of trading on the NYSE, which comprises a specialist competing with limit order flow, obfuscates the comparison. In 2001, a structural change was implemented on the Italian Bourse. Many stocks that traded in an auction market switched to a specialist market, where the specialist controls order flow. Results confirm that liquidity is significantly improved when stocks commence trading in the specialist market. Analysis of the components of the bid-ask spread reveal that the adverse selection component of the spread is significantly reduced. This evidence suggests that specialist market structures provide greater liquidity to market participants.     

The Making of a Dealer Market: From Entry to Equilibrium in the Trading of Nasdaq Stocks

This paper provides an analysis of the nature and evolution of a dealer market for Nasdaq stocks. Despite size differences in sample stocks, there is a surprising consistency to their trading. One dealer tends to dominate trading in a stock. Markets are concentrated and spreads are increasing in the volume and market share of the dominant dealer. Entry and exit are ubiquitous. Exiting dealers are those with very low profits and trading volume. Entering market makers fail to capture a meaningful share of trading or profits. Thus, free entry does little to improve the competitive nature of the market as entering dealers have little impact. We find, however, that for small stocks, the Nasdaq dealer market is being more competitive than the specialist market.     

Price discovery in government bond markets

Price discovery in government bond markets is explored using Norwegian data including trades from both tiers of the market and dealer identities. The results show that while aggregate interdealer order flow explains one-fourth of daily yield changes, aggregate customer order flow has little explanatory power. Dealers are heterogeneously informed and appear to have different sources of information. While some dealers mainly rely on their customer trades, others appear to rely on skill in acquiring and interpreting other relevant information, suggesting that dealers play an independent role in the price discovery process.