Specialists,Limit‐Order Traders,and the Components of the Bid‐Ask Spread

This study compares the components of the bid‐ask spread estimated from quotes that reflect the trading interest of specialists with those estimated from limit‐order quotes and all available quotes for a sample of New York Stock Exchange (NYSE) stocks. The results show that the adverse selection component of the spread estimated from specialist quotes is significantly smaller than the corresponding figures from limit‐order quotes and entire quotes. We interpret this as evidence that NYSE specialists transfer at least a part of adverse selection costs to outsiders through the discretionary use of limit orders. Our results show that the estimation/interpretation of the components of the spread using quote data that include both specialist and limit‐order interests is problematic.     

Trade classification algorithms for electronic communications network trades

Ellis et al. [Ellis, K., Michaely, R., O’Hara, M., 2000. The accuracy of trade classification rules: Evidence from Nasdaq. Journal of Financial and Quantitative Analysis 35 (4), 529–551] find that trade classification rules have limited success in classifying trades which execute inside the quotes. We reconfirm this result and propose an alternative algorithm to improve the classification accuracy for trades inside the quotes. This alternative algorithm improves the overall success rate for classifying trades, especially for trades that occur inside the quotes. Additionally, we show that the Lee and Ready [Lee, C., Ready, M., 1991. Inferring trade direction from intraday data. Journal of Finance 46, 733–747] and Ellis et al. (2000) trade classification algorithms provide biased estimates of the actual effective spreads and price impacts, while our algorithm provides statistically unbiased estimates of actual effective spreads and price impacts.     

On the marketing of IPOs

Derrien [2005. Journal of Finance 60, 487–521] and Ljungqvist et al. [2006. Journal of Business] build upon the work of Miller [1977. Journal of Finance 32, 1151–1168] and claim that issuers and the regular customers of investment bankers benefit from the presence of sentiment investors (noise traders) in the market for an initial public offering (IPO). Thus we argue that investment bankers have an incentive to promote an IPO to induce sentiment investors into the market for it. Consistent with this motivation and these models, we expect that the promotional efforts of investment bankers should influence the compensation of investment bankers, the valuation of an IPO, its initial returns and trading, the wealth gains of insider shareholders, and the likelihood that an issuer switches investment bankers for a subsequent seasoned equity offering. Examining data for a sample of IPOs from 1993 through 2000, we find evidence consistent with these predictions and so with the proposition that an investment banker's ability to market an IPO to sentiment investors is important.     

The impact of designated market makers on security prices

This paper is divided into two distinct parts. Part I, Empirical Evidence, tests a previously formulated variance, thinness relationship for security returns. First quarter 1972 daily returns variance is regressed on market value of shares, share price, trading activity, sales variance, and institutional holdings for 178 firms selected by stratified random sampling from AMEX and NYSE (specialist exchanges), and from Tokyo and Rio de Janeiro (non-specialist exchanges). The principal finding is that returns variance and market value are inversely related on non-specialist exchanges, but not on specialist exchanges; this difference is attributed to specialists' impact. Part II, Policy Proposals, discusses the manner in which designated market makers may be effectively incorporated into a continuous auction exchange. Issues discussed include: desirability of price stabilization, transfers implicit in the existing U.S. specialist system, consolidation and public availability of the limit order book, number of designated market makers for a security, competitive bidding, and compensation for performing the price stabilization function. Stabilization is modeled as an external economy, and specific policy proposals for internalizing it are advanced.     

An Intraday Examination of the Components of the Bid–Ask Spread

Using transactions data for a sample of NYSE stocks, we decompose the bid–ask spread (BAS) into order–processing (OP) and asymmetric information (AI) components using the techniques of George, Kaul, and Nimalendran (1991) and Madhavan, Richardson, and Roomans (1997). McInish and Wood (1992) demonstrate that the intraday behavior of BASs can be explained by variables measuring activity, competition, risk, and information. We investigate whether these variables explain the behavior of the OP and AI components of the spread over the trading day. We conclude that, on balance, the variables that determine the aggregate BAS also determine its intraday components.     

Adverse Selection and the Opaqueness of Insurers

While adverse selection problems between insureds and insurers are well known to insurance researchers, few explore adverse selection in the insurance industry from a capital markets perspective. This study examines adverse selection in the quoted prices of insurers' common stocks with a particular focus on the opacity of both asset portfolios and underwriting liabilities. We find that more opaque underwriting lines result in greater adverse selection costs for property-casualty (P-C) insurers. A similar effect is not apparent for life-health (L-H) insurers and we find no effect of asset opaqueness on adverse selection for either L-H or P-C insurers.     

Nasdaq and The Chicago Stock Exchange: An Analysis of Multiple Market Trading

We analyze a set of 97 NASD-listed securities that trade on both the Nasdaq and Chicago Stock Exchange (CHX) to determine if trading costs and price improvement differ between the two markets. We find that order execution costs, which we define by the traded spread and the signed effective half-spread, are significantly lower on the CHX. This difference is consistent over trade types and for trades of at least 1,000 shares. Also, we find that trades occurring on the CHX receive more price improvement than do those occurring on Nasdaq.     

Short‐ and Long‐Term Effects of Multimarket Trading

We analyze short‐ and long‐term effects of multimarket trading by examining the entries of multiple markets into transacting three ETFs, DIA, QQQ, and SPY. We find that large‐scale entries improve overall market quality, while small‐scale entries have ambiguous effects. Our results show that the competition effect dominates the fragmentation effect over a long horizon and that market fragmentation leads to a decline in trading costs. Further, we find that the order handling rules help mitigate the fragmentation effect and facilitate the competition effect. We do not find that multimarket trading harms price efficiency or increases price volatility.