The Value of the Designated Market Maker
35 Pages Posted: 19 May 2005
Date Written: May 17, 2005
The recent proliferation of electronic exchanges raises questions regarding the need for intermediaries with affirmative obligations to maintain markets. In this study, we examine the value of augmenting the public supply of liquidity with a designated market maker, or dealer, for a sample of less liquid firms that trade on the Paris Bourse. The results indicate that firms with designated dealers trade more frequently and have lower book imbalances, and that younger firms, smaller firms, and less volatile firms are more likely to prefer a designated dealer. We examine market quality before and after dealer introduction and present direct evidence that the designated dealer improves market quality by reducing the temporal imbalances in order flow. Around the announcement of dealer introduction, stocks experience an average cumulative abnormal return of nearly five percent that is positively correlated with improvements in liquidity. Overall, these results suggest that a designated dealer can improve the terms of trade offered by public limit orders and that purely endogenous liquidity provision may not be optimal for all securities.
Keywords: Specialist, dealer, electronic exchange, liquidity
JEL Classification: G10, G14
Suggested Citation: Suggested Citation