How Do Designated Market Makers Create Value for Small-Caps?
57 Pages Posted: 14 Mar 2006 Last revised: 2 Aug 2011
Date Written: August 1, 2011
A poor liquidity level and a high liquidity risk significantly raise the required return for small-cap stocks. Euronext allows these firms to hire designated market makers (DMMs) who guarantee a minimum liquidity supply for a lump sum annual fee. In an event study based on 74 DMM stocks, we find that the contract improves liquidity level, reduces liquidity risk, and generates an average abnormal return of 3.5%. DMMs participate in more trades and incur a trading loss on high quoted-spread days, i.e., days when their constraint is likely to bind. Finally, DMMs reduce the size of pricing errors.
Keywords: liquidity, liquidity risk, designated market makers, small-cap, volume, volatility, price discovery
JEL Classification: G10
Suggested Citation: Suggested Citation