Multidimensional Competition on NASDAQ: Did Traders Gain When Dealers Stopped Avoiding Odd-Eighth Quotes?

Abstract

Apparently spurred by allegations of collusive pricing, dealers in the NASDAQ stocks Apple, Amgen, Cisco, and Microsoft began offering odd-eighth quotes in May 1994. Intel dealers followed shortly thereafter. If the associated dramatic reduction in quoted spreads represented a move to competitive pricing of transaction services, investors would have increased their trading volume. If, by contrast, wide spreads and avoidance of odd-eighth quotes motivated dealers to compete on dimensions such as payments for order flow, immediacy, depth, and other services, the fall in spreads would have undercut such inducements. It is possible that the wide spreads associated with the avoidance of odd-eighth quotes supported an efficient set of transaction services and prices, in which case the true cost of transacting would have increased when dealers began offering odd-eighth quotes. In this case, volume would have decreased. After correcting for NASDAQ-wide and other exogenous determinants of volume, we find a statistically significant increase in the five affected stocks, as predicted by the collusion hypothesis. The volume increase is, however, extremely small compared to the fall in spreads, which suggests that transaction services were also reduced.

JEL Classification: G10, L41