Uncertainty,market structure,and liquidity

In this study we show that market uncertainty [measured by the Chicago Board Options Exchange Market Volatility Index (VIX)] exerts a large market-wide impact on liquidity, which gives rise to co-movements in individual asset liquidity. The effect of VIX on stock liquidity is greater than the combined effects of all other common determinants of stock liquidity. We show that the uncertainty elasticity of liquidity (UEL: percent change in liquidity given a 1% change in VIX) has increased around regulatory changes in the US markets that increased the role of public traders in liquidity provision, reduced the minimum allowable price variation, weakened the affirmative obligation of NASDAQ dealers, and abolished the specialist system on the NYSE.     

The dynamics of quote adjustments

Liquidity providers on the NYSE make faster quote adjustments towards equilibrium spreads and depths than they do on NASDAQ. Liquidity providers in both markets make faster spread and depth adjustments for stocks with more frequent trading, greater return volatility, higher prices, smaller market capitalizations, and smaller trade sizes. We find that stocks with greater information-based trading and in more competitive trading environments exhibit faster quote adjustments. The speed of quote adjustment is faster after decimalization in both markets. These results are robust and not driven by differences in stock attributes between the two markets or time periods. Overall, our results indicate that stock attributes, market structure, and tick size exert a significant impact on the speed of quote adjustment.     

Exit,Survival, and Competitive Equilibrium in Dealer Markets

In this study we analyze dealer exit, survival, and competitive equilibrium in the NASDAQ Stock Market using data from a unique period that entails major changes in regulatory and competitive environments. We decompose the forces that affect dealer survival into market factors and dealer attributes. Market factors encompass those variables that affect the demand for and profitability of dealer services as a whole. Variation in survival probability across dealers results mainly from their competitive advantages in business strategies, information, quote aggressiveness, access to order flow, and economies of scale. On the whole, our results suggest that dealer markets exhibit a Darwinian survival of the fittest.     

Regulation NMS and Market Quality

We show that both the quoted and effective spreads increased, the quoted depth decreased, and the market quality index decreased after the implementation of Regulation National Market System (NMS) (Reg NMS). We also find an increase in the price impact of trades and the dispersion of the pricing error after Reg NMS. The order execution speed is slower, the order fill rate is lower, and the order cancellation rate is higher for most trades after Reg NMS. Hence, contrary to the Securities and Exchange Commission's belief, Reg NMS has proven to be detrimental to most traders. NASDAQ provided faster and more reliable executions than the NYSE/AMEX, and NASDAQ gained market shares from the NYSE/AMEX and other trading venues after Reg NMS.     

Order preferencing, adverse-selection costs, and the probability of information-based trading

Although prior studies offer various conjectures on the causes and consequences of order preferencing, there is only limited empirical evidence. In this study, we show that the extent of order preferencing is significantly and negatively related to both the adverse-selection component of the spread and the probability of information-based trading. This result is consistent with the prediction of the clientele-pricing hypothesis that dealers (brokers) selectively purchase (internalize) orders based on information content. Our results suggest that order preferencing may not be as harmful as some researchers have suggested and offer some rationale for its prevalence in securities markets with heterogeneously informed traders. JEL Classification G18 · G19     

Cleaning house: Stock reassignments on the NYSE

A frequently occurring, yet unexplored, phenomenon of the New York Stock Exchange specialist system is that of reassignments of stocks by specialist firms on the floor of the Exchange. These events change the portfolios at the individual specialist level by reassigning one or more stocks from one individual specialist portfolio to another. We find that reassigned stocks have unusually wide spreads before reassignments and experience a decline in spreads to levels comparable to matched stocks after the reassignment. This improvement in liquidity is associated with a reduced cost of capital for the reassigned firms. We find that portfolio size, and industry and size concentration of the individual specialist portfolios are associated with the decision of specialist firms to reassign stocks.     

Quote-based competition,market share,and execution quality in NASDAQ-listed securities

We show that competitive quotes help increase dealer market share on NASDAQ, despite the fact that a large proportion of order flow is preferenced. We find that decimal pricing and the introduction of new trading platforms such as SuperSOES and SuperMontage have significantly changed the effect of quote aggressiveness on dealer market share. In particular, decimal pricing reduces (increases) the price (size) elasticity, SuperSOES increases the size elasticity, and SuperMontage increases both the size and price elasticity of dealer market share. We also show that market centers provide greater price improvements and faster executions when they post competitive quotes.     

Transparency and market quality: Evidence from SuperMontage

In this study, we examine the effect of pre-trade transparency on market quality using data before and after the introduction of SuperMontage. Our results show that both bid–ask spreads and return volatility declined significantly after the implementation of SuperMontage. In addition, SuperMontage led to significant improvements in the SEC Rule 605 execution quality measures (e.g., faster executions and higher fill rates). Overall, our results indicate that SuperMontage improved market and execution quality on NASDAQ through greater pre-trade transparency and the integrated, more efficient quotation and trading system.