Market vs. Limit Order Submission Behavior at a NASDAQ Market Maker

27 Pages Posted: 7 Dec 2000

See all articles by Jeffrey Smith

Jeffrey Smith

National Association of Securities Dealers, Inc., NASD

Date Written: July 7, 2000

Abstract

This paper considers the order type decision (market vs. limit order) of retail investors. The key question addressed is the extent to which stock-specific characteristics influence the order decision. The focus is primarily empirical, being based on a sample of proprietary order data obtained from a Nasdaq market maker. A simple theoretical model of order submission is put forward to guide the empirics. The stock-specific characteristics considered are the spread, price, volatility and trading activity of the stock. These characteristics serve as explanatory variables in a multinomial logit model which predicts the probability of four discrete order types, based on the aggressiveness of the order. By comparing the results from a 1996 sample with those from a 1998 sample, the impact of the landmark Nasdaq changes of 1997 is also assessed. It was found that limit orders are more prevalent when spreads are wide, as investors attempt to mitigate against high transaction costs. It was also found that limit orders are more prevalent for stocks with high price volatility, suggesting the public investors may have a comparative advantage over professional market makers in the provision of liquidity for volatile stocks. The market reforms of 1997 tended to increase the incidence of limit orders.

Suggested Citation

Smith, Jeffrey W., Market vs. Limit Order Submission Behavior at a NASDAQ Market Maker (July 7, 2000). AFA 2001 New Orleans. Available at SSRN: https://ssrn.com/abstract=253013 or http://dx.doi.org/10.2139/ssrn.253013

Jeffrey W. Smith (Contact Author)

National Association of Securities Dealers, Inc., NASD ( email )

1801 K Street, NW
Washington, DC 20006-1500
United States
(202) 728-8032 (Phone)
(202) 728-8906 (Fax)

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