How Do Designated Market Makers Create Value for Small-Caps?
Albert J. Menkveld
VU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA); Duisenberg School of Finance
VU University Amsterdam
August 1, 2011
AFA 2008 New Orleans Meetings Paper
EFA 2006 Zurich Meetings
A poor liquidity level and a high liquidity risk significantly raise the required return for small-cap stocks. Euronext allows these firms to hire designated market makers (DMMs) who guarantee a minimum liquidity supply for a lump sum annual fee. In an event study based on 74 DMM stocks, we find that the contract improves liquidity level, reduces liquidity risk, and generates an average abnormal return of 3.5%. DMMs participate in more trades and incur a trading loss on high quoted-spread days, i.e., days when their constraint is likely to bind. Finally, DMMs reduce the size of pricing errors.
Number of Pages in PDF File: 57
Keywords: liquidity, liquidity risk, designated market makers, small-cap, volume, volatility, price discovery
JEL Classification: G10working papers series
Date posted: March 14, 2006 ; Last revised: August 2, 2011
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