Who makes markets

A dealer needs access to order flow and information to make a market profitably in a Nasdaq stock. Several variables that proxy for the stocks that an individual market maker's brokerage customers trade, including volume, location, underwriting participation and analyst coverage, are significant determinants of market making activity. Informational advantages may also factor in the market making decision as evidenced by dealers specializing in industries. These findings suggest that individual dealers have competitive advantages in making markets in specific stocks, and that potential market making competition comes from the dealers who share those advantages rather than all Nasdaq market makers.     

Private and public disclosures and the efficiency of stock prices

In this paper I examine the effects of private and public disclosures on the informational efficiency of stock prices. In addition to making a public announcement such as an earnings announcement, a public firm can make private disclosure to an analyst. If the analyst's relative information advantage is below a threshold level, private disclosure to the analyst leads to more efficient stock price. I demonstrate that the allocation of information across market participants is an important determinant of price efficiency. While accounting regulators often argue the need for equal access to information, the paper shows that there are conditions under which a limited amount of informational inequality may lead to more efficient stock prices.     

Competition on the Nasdaq and the Impact of Recent Market Reforms

This paper examines the effect of recent market reforms on the competitive structure of the Nasdaq. Our results show that changes in inventory and information costs cannot explain the post-reform decrease in bid-ask spreads. We interpret this as evidence that the reforms have reduced Nasdaq dealers' rents. Additionally, we find that the difference between NYSE and Nasdaq spreads have been greatly diminished with the new rules. Further, the reforms have resulted in an exit, ceteris paribus , from the industry for market making. Overall, our results provide strong evidence that the reforms have improved competition on the Nasdaq.     

The impact of sell-side analyst research coverage on an affiliated broker’s market share of trading volume

Using NASDAQ reported individual stock level trading volume, we find that analyst research coverage on a stock increases the level of an affiliated broker’s market share of trading volume in that stock by 0.8 percent, on average, which corresponds to an additional annual volume of about one million shares in an average stock. Optimistic recommendations increase the level of market share by an additional 0.3 percent, on average, which is consistent with the notion that analysts have an incentive to issue optimistic recommendations. Also, a broker’s market share of volume increases on average when an affiliated analyst changes his/her recommendation, and decreases with the length of time during which an analyst maintains the same recommendation on a stock. The latter findings suggest that sell-side institutions are rewarded for providing new information to the market and for ongoing research services.     

Isolating the Information Content of Equity Analysts' Recommendation Changes,Post Reg FD

We investigate the information content of equity analysts' recommendation changes subsequent to the passage of Regulation Fair Disclosure. We find that analyst upgrades (downgrades) are associated with positive (negative) abnormal returns. Overall, stock prices tend to react significantly more strongly to recommendation changes accompanied by news events than to those that are not. Even so, returns around recommendation changes not accompanied by news are significantly different from zero. This result holds after controlling for firm‐specific variables and the incidence of multiple simultaneous recommendation changes. We conclude that analyst recommendation changes, in and of themselves, are informative.     

The role of the business press in the pricing of analysts’ recommendation revisions

We investigate the information-dissemination role of the business press by examining the coverage of analyst recommendation revisions. Consistent with the press providing wider dissemination of analyst reports, we find evidence that coverage of analyst recommendation revisions significantly increases the initial market reaction to these revisions and decreases the subsequent price drift. Furthermore, we find that news flash coverage, rather than in-depth coverage, of a recommendation revision drives both the initial market reaction results and drift results. Finally, we show that broader press coverage influences the activities of large-trade institutional investors but not high-frequency traders. Overall, our findings suggest a complementary role between analysts and the business press: increased dissemination of recommendation revisions, rather than information creation on the part of the business press, serves to better inform the market about analyst recommendation revision decisions.

     

Do independent research analysts issue more or less informative recommendation revisions?

This paper studies whether independent research analysts issue more informative stock recommendation revisions than investment bank analysts. I find independent analyst recommendation upgrades and downgrades significantly less informative. I also investigate whether the identified differences in informativeness are the result of systematic cross-sectional variation in analyst ability, portfolio complexity, and brokerage firm resources. Including these variables reduces the disparity in information content between groups. However, independent revisions continue to have lower informativeness. I follow prior research and compute daily buy-and-hold abnormal returns to portfolios formed based on analyst firm type. I find that investment bank analyst portfolios generally outperform those of independent research analysts. Lastly, I examine market reactions before and after the Global Settlement Agreement that was enacted to limit the perceived conflicts in the industry. Lastly, investment bank analyst upgrades generate an 18.7% greater reaction in the post-regulation period, suggesting the Global Settlement helped mitigate biased research. Independent analysts continue to issue less informative recommendations.     

Are analyst stock recommendation revisions more informative in the post‐IFRS period?

This paper investigates whether the mandatory IFRS adoption has affected the informativeness of analyst recommendation revisions in Europe. Although prior studies document that IFRS adoption improved analyst forecast attributes, the impact of IFRS cannot be completely assessed without examining how the market reacts to information‐rich events in an environment with enhanced disclosure. To examine this question we utilize a difference‐in‐differences design using as main control sample firms that had voluntarily adopted IFRS before the EU's mandated switch. Overall, our evidence suggests that after the mandatory adoption of IFRS, both analyst upgrades and downgrades are more informative. These results hold after controlling for a number of variables that capture analyst, firm and information environment characteristics and are robust to a number of sensitivity analyses including the use of a US control sample. Finally, we examine whether our results are sensitive to the level of accounting enforcement. We find that analyst downgrades are more informative in the post‐IFRS period for firms in both high and low enforcement environments. Analyst upgrades, however, are more informative only if they are issued for firms in high enforcement countries.     

Herding among Investment Newsletters: Theory and Evidence

A model is developed which implies that if an analyst has high reputation or low ability, or if there is strong public information that is inconsistent with the analyst's private information, she is likely to herd. Herding is also common when informative private signals are positively correlated across analysts. The model is tested using data from analysts who publish investment newsletters. Consistent with the model's implications, the empirical results indicate that a newsletter analyst is likely to herd on Value Line's recommendation if her reputation is high, if her ability is low, or if signal correlation is high.     

ADRs,Analysts, and Accuracy: Does Cross Listing in the United States Improve a Firm's Information Environment and Increase Market Value?

This paper investigates the relation between cross listing in the United States and the information environment of non‐U.S. firms. We find that firms that cross list on U.S. exchanges have greater analyst coverage and increased forecast accuracy than firms that are not cross listed. A time‐series analysis shows that a change in analyst coverage and forecast accuracy occurs around cross listing. We also document that firms that have more analyst coverage and higher forecast accuracy have higher valuations. Furthermore, the change in firm value around cross listing is correlated with changes in analyst following and forecast accuracy, suggesting that cross listing enhances firm value through its effect on the firm's information environment. Our findings support the hypothesis that cross‐listed firms have better information environments, which are associated with higher market valuations.     

Payments for Order Flow on Nasdaq

We present a model of Nasdaq that includes the two ways in which marketmakers compete for order flow: quotes and direct payments. Brokers in our model can execute small trades through a computerized system, preferencing arrangements with marketmakers, or vertical integration into market making. The comparative statics in our model differ from those of the traditional model of dealer markets, which does not capture important institutional features of Nasdaq. We also show that the empirical evidence is inconsistent with the traditional model, which suggests that preferencing and vertical integration are important components in understanding Nasdaq.     

RECENT GROWTH IN NASDAQ TRADING VOLUME AND ITS RELATION TO MARKET VOLATILITY

We document a significant increase in Nasdaq trading volume relative to New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) trading volumes. Although recent increases in the number of shares traded are reported in the financial press, we also find it present in the percentage of dollar values traded. We then examine correlations between trading volume and several measures of market volatility. Nasdaq volume appears to be more closely correlated with residual variance, while NYSE and AMEX volumes are more closely correlated with overall market variance. We conclude that the type and quantity of information driving trading are different on Nasdaq than on the two exchanges, and that the relative growth in Nasdaq volume cannot be attributed solely to differences in the methods of counting volume in the two market environments.     

The Impact of Market Maker Competition on Nasdaq Spreads

This study utilizes a comprehensive database containing monthly information on the number of market makers for about 5,288 Nasdaq securities over an eight-year period to investigate the impact of competition on spreads. A variety of models are estimated in order to demonstrate the robustness of the results that include four specific findings: (1) the number of market makers has a negative and highly significant impact on spreads; (2) the relation is nonlinear with a decreasing impact by the marginal market maker; (3) Nasdaq spreads have been declining over time; and (4) structural changes in Nasdaq are associated with significant changes in the relationship between spread and the number of market makers. One improvement over the literature includes allowing endogenous competition through the use of instrumental variables.     

Information,sell-side research,and market making

The interaction between an investment bank's research and market making arms may have important implications for the trading of a firm's stock. We investigate the impact that research has on the liquidity provided by the bank's market maker. Utilizing a large sample of Nasdaq firms, we show that market makers whose banks also provide research coverage provide more liquidity and contribute more to price discovery than do market makers without such research coverage. Finally, we show that such “affiliated” market makers are less affected by uncertainty following earnings announcements. Our results provide new evidence on the sources of liquidity improvements for Nasdaq firms, and suggest that the information produced by banks in the sell-side research process is beneficial to their market makers.     

Information Diffusion and Overreaction: Evidence from the Chinese Stock Market

This paper empirically examines the relation between overreaction and the speed of information diffusion in the Chinese stock market. Industry-adjusted firm size and residual analyst coverage are used to proxy the speed of information diffusion. We document strong evidence that the profitability of a monthly contrarian strategy decreases with industry-adjusted firm size or residual analyst coverage. Moreover, the profitability of contrarian strategies survives for a longer horizon for stocks with slower information diffusion than for those with faster information diffusion. This result holds true even if risk, bid-ask spread, lead-lag effect, inventory costs, and limits to arbitrage are properly accounted for. Our findings suggest that information environment and information diffusion determine the extent of overreaction.     

Market reactions to the closest peer firm’s analyst revisions

Prior analyst literature focuses on the impact of financial analysts on the firms they cover, and prior information-transfer literature concentrates on the externalities of information provided by management. This paper fills gaps in both streams of literature by examining the focal firm’s market reactions to the closest peer firm’s (identified by product similarity) analyst revisions. We find that the focal firm’s stock price reacts to the closest peer’s analyst revisions made by analysts who are not covering the focal firm. The focal firm’s cumulative abnormal return for a five-day window centered on the revision date is 0.54% higher if the peer firm’s analyst revision magnitude is in the top decile than if it is in the bottom decile. Cross-sectional tests show that the sensitivity of the focal firm’s market reactions to the peer firm’s revisions increases with the revision informativeness and the similarity between the focal firm and the peer firm. In addition, we find that focal firms do not react to peer firms’ revisions in industries with strong competition where the competitive effects cancel out the spillover effects. Finally, we find that the focal firm’s market reactions can predict its own future analyst revisions, suggesting that the reactions are at least partially rational.     

Product market competition,competitive strategy,and analyst coverage

This paper examines how product market competition and strategic interactions among peer firms influence analyst coverage. First, we hypothesize that product market competition increases both the demand and supply of analyst coverage. Using three variations of industry concentration ratios and a firm specific measure of competition, we test and find a positive and significant effect of market competition on analyst coverage. Second, we explore an information transfer channel through which product market affects analyst coverage. We hypothesize that information flows more freely among firms selling similar products. Such information flows lowers analyst information collection and processing costs, which in turn increases analyst coverage. Using product similarity index developed by Hoberg and Phillips (J Polit Econ 124(5):1423–1465, 2016) to capture the effect of information transfer, we find that analyst coverage increases with product similarity. Third we examine the role of competitive strategy in analyst coverage. We split our sample into markets of strategic complements and strategic substitutes. We find that the effect of market competition and analyst coverage is more pronounced in markets where firms compete as strategic complements.     

Which types of analyst firms are more optimistic?

Research optimism among securities analysts has been attributed to incentives provided by underwriting activities. We examine how analysts’ forecast and recommendation optimism varies with the business activities used to fund research. We find that analysts at firms that funded research through underwriting and trading activities actually made less optimistic forecasts and recommendations than those at brokerage houses, who performed no underwriting. Optimism was particularly low for bulge underwriter firm analysts, implying that firm reputation reduces research optimism. There is also evidence that analysts at retail brokerage firms are more optimistic than those serving only institutional investors. We conclude that analyst optimism is at least partially driven by trading incentives.     

Information uncertainty,investor sentiment,and analyst reports

This study investigates the relationships among information uncertainty, investor sentiment, analyst reports, and stock returns in a unified framework. The effects of analyst reports on stock returns depend on the degrees of information uncertainty, indicating that recommendation upgrades (downgrades) convey more valuable positive (negative) information under higher information uncertainty. Such stock market reactions are significantly explained by investor sentiment when information uncertainty is high. Our empirical findings are robust to changes in abnormal return measures and information uncertainty proxies.     

What is the effect of an additional dollar of IPO proceeds?

We examine the effect of IPO proceeds on post-IPO liquidity and market monitoring. To do so we exploit variation in the amount of proceeds raised that is unrelated to firm size and manager decisions using an instrumental variable approach. We find that marginal increases in IPO proceeds lead to large increases in liquidity, analyst coverage, and institutional ownership in the first two years a firm is public. Increases in IPO proceeds also lead to more frequent follow-on offerings and longer survival as a public firm. We find evidence that immediate shocks to ownership dispersion represent one plausible channel through which changes in IPO proceeds affect long-run liquidity and market monitoring. Overall, our findings support the theoretical liquidity and market quality benefits associated with reductions in ownership concentration.