Do 'Thinly-Traded' Stocks Benefit from Specialist Intervention?

Posted: 17 Jun 2004

See all articles by Mahendrarajah Nimalendran

Mahendrarajah Nimalendran

University of Florida - Department of Finance, Insurance and Real Estate

Giovanni Petrella

Università Cattolica del Sacro Cuore

Abstract

This paper addresses the issue of the optimal trading system for less actively traded stocks. Several studies have examined the quality and performance of alternative market structures for actively traded stocks. However, very few empirical studies compare the performance of different market structures for less actively traded (i.e., 'thinly-traded') stocks. In 1997 the Italian Stock Exchange (ISE) implemented the Thin Stocks Project to improve market quality of 'thinly-traded' stocks. Under this project, stocks defined as 'thinly-traded' by the ISE were given the option to trade either on a pure order driven market with limit order book (POD), or a hybrid order driven market with specialist and limit order book (HOD). In this paper we compare the relative performance of the two trading systems for 'thinly-traded' stocks using several metrics of market quality. We find that the hybrid order driven system offers superior performance along several quality metrics. In particular, the hybrid order driven system offers lower execution costs, greater depth, significant increase in the depth-to-spread ratio, and a decrease in adverse selection cost. Very illiquid stocks benefit more from adopting a hybrid system than moderately illiquid ones. The results are robust to different measures of execution costs, sampling periods, and modeling approaches. Our findings support the analysis by Grossman and Miller (1988) that a specialist can enhance liquidity of 'thinly-traded' stocks.

Keywords: Thin Markets, Specialist, Market Quality, Trading Costs

JEL Classification: G14, G18, D23, L22

Suggested Citation

Nimalendran, Mahendrarajah and Petrella, Giovanni, Do 'Thinly-Traded' Stocks Benefit from Specialist Intervention?. Journal of Banking and Finance, Vol. 27, No. 9, pp. 1823-1854, September 2003. Available at SSRN: https://ssrn.com/abstract=556287

Mahendrarajah Nimalendran (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-9526 (Phone)
352-392-0301 (Fax)

Giovanni Petrella

Università Cattolica del Sacro Cuore ( email )

Largo Gemelli 1
Milano, 20123
Italy
+39 02 72343007 (Phone)

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