Market Making, the Tick Size and Payment-for-Order-Flow: Theory and Evidence

Posted: 6 Sep 1999

See all articles by Tarun Chordia

Tarun Chordia

Emory University - Department of Finance

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: August 1993

Abstract

This paper analyzes the effects of a finite tick size and the practice of 'payment-for-order-flow' on competition between NYSE and non-NYSE market makers. Due to the presence of non-specialist market makers, order submitters find that their NYSE orders are sometimes executed at better than quoted prices. Our analysis implies that even if the NYSE reservation price is superior to its non-NYSE counterpart, brokers may, due to payment-for-order-flow, prefer to execute orders off the NYSE floor. Further, if, unlike NYSE specialists, non-NYSE market makers can more easily offset their inventory exposure (using, for example, options markets), they offer more competitive prices. In accordance with the implications of the model, we provide empirical evidence that non-NYSE market makers trade a larger fraction of the smaller order sizes and offer fewer price improvement opportunities. Also, large companies appear to have enhanced price improvement opportunities on the NYSE, suggesting that the number of non-specialist market positively affects such opportunities.

JEL Classification: G00

Suggested Citation

Chordia, Tarun and Subrahmanyam, Avanidhar, Market Making, the Tick Size and Payment-for-Order-Flow: Theory and Evidence (August 1993). Available at SSRN: https://ssrn.com/abstract=5797

Tarun Chordia (Contact Author)

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-1620 (Phone)
404-727-5238 (Fax)

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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