Do Correlated Exposures Influence Intermediary Decision-Making? Evidence from Trading Behavior of Equity Dealers

41 Pages Posted: 3 Nov 2008

See all articles by Narayan Y. Naik

Narayan Y. Naik

London Business School - Institute of Finance and Accounting

Pradeep K. Yadav

University of Oklahoma Price College of Business

Date Written: October 2001

Abstract

This paper investigates whether dealers trading and pricing decisions are governed by their equivalent inventories (based on total returns as in Ho and Stoll, 1983 or on unhedgeable returns as in Froot and Stein, 1998) or by their ordinary inventories, as would be the case in a decentralized market-making organizational structure. It finds that ordinary inventories, and not equivalent inventories best explain dealers quote placement strategy, which dealer executes trades and the quality of execution offered to the trades. This finding is consistent with decentralized market making where, due to information sharing difficulties or the nature of compensation contracts, individual dealers care only about risk of stocks managed by them, and not the positions of other dealers within the firm.

Keywords: Dealer firm, equivalent inventory, correlated risk exposure, unhedgeable risk, effective spreads

Suggested Citation

Naik, Narayan Y. and Yadav, Pradeep K., Do Correlated Exposures Influence Intermediary Decision-Making? Evidence from Trading Behavior of Equity Dealers (October 2001). NYU Working Paper No. FIN-01-014. Available at SSRN: https://ssrn.com/abstract=1294469

Narayan Y. Naik (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
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Pradeep K. Yadav

University of Oklahoma Price College of Business ( email )

307 W.Brooks, Room 205A Division of Finance
Norman, OK 73019
United States
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4053255491 (Fax)

HOME PAGE: http://www.ou.edu/price/finance/faculty/pradeep_yadav.html

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