Order preferencing, adverse-selection costs, and the probability of information-based trading |
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| Authors: | Kee H. Chung Chairat Chuwonganant D. Timothy McCormick |
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| Affiliation: | (1) Department of Finance and Managerial Economics, State University of New York (SUNY) at Buffalo, Buffalo, NY 14260, USA;(2) Department of Accounting and Finance, Indiana University-Purdue University at Fort Wayne, Fort Wayne, IN 46805, USA;(3) The Securities and Exchange Commission, 100 F Street, NE Washington, DC, 20549 |
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| Abstract: | 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 |
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| Keywords: | Order preferencing Internalization Components of the spread Adverse-selection costs Information-based trading |
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