Can Quote Competition Reduce Preferenced Trading? A Reexamination of the SEC's 1997 Order Handling Rules

22 Pages Posted: 16 Mar 2013

See all articles by S. Ghon Rhee

S. Ghon Rhee

University of Hawaii - Shidler College of Business; University of Hawaii - Department of Financial Economics and Institutions

Ning Tang

Wilfrid Laurier University

Date Written: March 2013

Abstract

In 1997, the SEC implemented the new order handling rules (OHRs) on the NASDAQ. We observe that some uncompetitive positions gained market share without improving quote competitiveness after the implementation of the OHRs. Also observed is a significant decline in the sensitivity of trading volume to quote competitiveness, indicating lower incentive for NASDAQ dealers to engage in quote competition in the post‐OHR regime. We find that positions that gained trading volume without improving quote competitiveness were less competitive and were more closely associated with stocks showing low information asymmetry, which suggests that preferenced trading might be responsible for the decline in the trading volume sensitivity. Examining entries and exits around the periods of adopting OHRs, we observe net entry of uncompetitive positions and net exit of competitive positions, which indicates that preferenced trading crowded out quote competition subsequent to the OHRs. Our findings suggest that forcing intense quote competition alone produced an unwanted effect that preferencing emerged as a more attractive alternative to quote competition.

Keywords: Preferenced trading, Quote competitiveness, Order flow competition, Order handling rules, Market reforms

JEL Classification: G18, G28

Suggested Citation

Rhee, S. Ghon and Tang, Ning, Can Quote Competition Reduce Preferenced Trading? A Reexamination of the SEC's 1997 Order Handling Rules (March 2013). Accounting & Finance, Vol. 53, Issue 1, pp. 243-264, 2013. Available at SSRN: https://ssrn.com/abstract=2234289 or http://dx.doi.org/10.1111/j.1467-629X.2012.00494.x

S. Ghon Rhee (Contact Author)

University of Hawaii - Shidler College of Business ( email )

2404 Maile Way
C-304, FEI/CBA
Honolulu, HI 96822
United States

University of Hawaii - Department of Financial Economics and Institutions ( email )

United States

Ning Tang

Wilfrid Laurier University ( email )

75 University Ave W
Waterloo, Ontario N2L 3C5
Canada

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