Price and Quantity Quotes on NASDAQ: A Study of Dealer Quotation Behavior

Abstract

In this article we analyze the quotation behavior of NASDAQ market makers using individual dealer quote and trade data. We find that the majority (58.2%) of quotes posted by NASDAQ dealers are noncompetitive (i.e., both the bid and ask quotes are not at the inside market) and only 19.5% (18.4%) of bid (ask) quotes are at the inside market. The percentage of dealer quotes that are at the inside market is higher for stocks with wider spreads, fewer market makers, and more frequent trading, and lower for stocks with larger trade sizes and higher return volatility. These results support our conjecture that dealers have greater incentives to be at the inside for stocks with larger market-making revenues and smaller costs. We also find that dealers post large depths when their quotes are at the inside and frequently quote the minimum required depth when they are not at the inside. We show that the latter quotation behavior leads to the negative inter-temporal correlation between dealer spread and depth.

Keywords: Spreads, Depths, Dealer quotes, NASDAQ, Liquidity providers

JEL Classification: G14