How Do Designated Market Makers Create Value for Small-Caps?

Menkveld, Albert J.; Wang, Ting

doi:10.2139/ssrn.890526

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How Do Designated Market Makers Create Value for Small-Caps?

AFA 2008 New Orleans Meetings Paper

EFA 2006 Zurich Meetings

57 Pages Posted: 14 Mar 2006 Last revised: 2 Aug 2011

See all articles by Albert J. Menkveld

Ting Wang

VU University Amsterdam

There are 2 versions of this paper

Date Written: August 1, 2011

Abstract

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

Menkveld, Albert J. and Wang, Ting, How Do Designated Market Makers Create Value for Small-Caps? (August 1, 2011). AFA 2008 New Orleans Meetings Paper, EFA 2006 Zurich Meetings, Available at SSRN: https://ssrn.com/abstract=890526 or http://dx.doi.org/10.2139/ssrn.890526