Market Conditions, Fragility and the Economics of Market Making
54 Pages Posted: 21 Nov 2012 Last revised: 13 Aug 2015
Date Written: August 12, 2015
Using audit-trail data from Toronto Stock Exchange, we find that market makers scale back in unison when market conditions are unfavorable, which contributes to covariation in liquidity supply, both within, and across stocks. Market conditions lower aggregate participation via their impact on trading profits and risk. Contrary to regulatory view, higher stock volatility is associated with more participation and higher profits, even after controlling for other market conditions, including stock volume. Fragility concerns extend to larger stocks, and to active participants. The Designated Market Maker mitigates periodic illiquidity created by synchronous withdrawal of market makers in large and small stocks.
Keywords: Market Makers; HFTs; Fragility; Volatility; Obligations
JEL Classification: G11, G12, G14, G24
Suggested Citation: Suggested Citation