Do NASDAQ Market Makers Collude? Evidence from 19c-3 Stocks

Abstract

Christie and Schultz find that bid-ask spreads are wider and odd-eighth quotes less frequent in the Nasdaq market versus the NYSE and AMEX. They suggest that collusion among market makers may account for these results, while others offer efficiency-based explanations. This paper attempts to distinguish the "collusion hypothesis" from "efficiency hypothesis" by examining trade and quote data from 19C-3 stocks, which trade in both the Nasdaq and NYSE markets. We find that spreads are significantly wider and spread revisions are significantly less frequent in the Nasdaq market compared with the NYSE, suggesting that microstructure imperfections, not collusion, may account for the wider spreads on Nasdaq. We also compare trade and quote data for the Nasdaq 19c-3 stocks with stocks with comparable trading volume that trade only on Nasdaq. We find that spreads are narrower and both odd-eight quotes and spread revisions are more frequent for the Nasdaq stocks which trade in both the Nasdaq and NYSE markets. While this result is consistent with the collusion hypothesis, we also find that pricing errors induced by microstructure considerations in the Nasdaq market are smaller for stocks that also trade simultaneously in the Nasdaq and NYSE markets. The results suggest that allegations of collusion are premature until the effects of microstructure considerations on spreads and quotes are better understood.

JEL Classification: G10