How Brokers Facilitate Trade for Long-Term Clients in Competitive Securities Markets

Abstract

In adverse-selection models of security market microstructure, a market-maker could enhance efficieny if he were willing to sustain short-term trading losses. We show that this deniable activity, which we term "facilitation", can be supported as a self-enforcing agreement between brokers-dealers and long-lived clients. The model predicts that brokers who provide facilitation services should also charge HIGHER (author's emphasis) fees to long-term clients for trades where the broker merely receives a commission. This prediction receives support from an analysis of brokerage rates on the Australian Stock Exchange. In addition, brokers who do not appear to provide facilitation services LOWER (author's emphasis) agency fees to large long-term clients.

JEL Classification: G15, G38