Do Dealer Firms Manage Inventory on a Stock-by-Stock or a Portfolio Basis?

42 Pages Posted: 22 Mar 2002

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

Abstract

This paper investigates whether dealer firms' 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 organisational structure. It finds that ordinary inventories, and not equivalent inventories best explain dealer firms' quote placement strategy, which dealer firm 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

JEL Classification: G12, G20, G24

Suggested Citation

Naik, Narayan Y. and Yadav, Pradeep K., Do Dealer Firms Manage Inventory on a Stock-by-Stock or a Portfolio Basis?. EFA 2002 Berlin Meetings Presented Paper. Available at SSRN: https://ssrn.com/abstract=302927 or http://dx.doi.org/10.2139/ssrn.302927

Narayan Y. Naik (Contact Author)

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

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 724 3317 (Fax)

Pradeep K. Yadav

University of Oklahoma Price College of Business ( email )

307 W.Brooks, Room 205A Division of Finance
Norman, OK 73019
United States
4053256640 (Phone)
4053255491 (Fax)

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

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