Competition and Market Structure of National Association of Securities Dealers Automated Quotations
International Review of Finance, Vol. 7, Nos. 3 & 4, 2007
Posted: 26 May 2013 Last revised: 30 May 2013
Date Written: September 23, 2006
In this paper, we study the relation among market structure, trading costs, and competition in National Association of Securities Dealers Automated Quotations (NASDAQ). In particular, we address the following questions: Do NASDAQ dealers exercise market power and extract economic rents in setting bid-ask spread? How persistent is the market power of dominant dealers? Our estimate of the rent is approximately b8.76, or 0.54% of stock price. The halflife of the persistence of this rent is approximately 20 months for the entire sample, while the half-life of younger stocks tend to be shorter than those of more mature stocks. Our result supports Schultz: NASDAQ dealers make markets only for stocks where they have competitive advantages in accessing order ﬂow and in information. It might take a while before a market maker poses effective competition to existing dominant market makers. In the meantime, incumbent market makers are able to exercise market power and appear to earn abnormally large proﬁts.
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