Paying for Market Liquidity: Competition and Incentives
60 Pages Posted: 18 Apr 2019
Date Written: March 2019
Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in adverse selection costs. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our results are of relevance for designing optimal contracts between exchanges and DMMs and for regulatory market oversight.
Keywords: High-Frequency Trading (HFT), Designated Market Makers (DMMs) Market Making, Adverse Selection, Liquidity Provision
JEL Classification: G12, G14
Suggested Citation: Suggested Citation