Transparency Matters: Price Formation in Presence of Order Preferencing
47 Pages Posted: 26 Oct 2006 Last revised: 14 Jan 2014
Date Written: October 1, 2011
Abstract
Using a market-making inventory model, we analyze the impact of order preferencing on dealers’quoting behavior by changing the degree of quote disclosure. We find that preferenced orders raise the inventory-holding costs of preferenced dealers, making them less able to post attractive quotes. In turn, competitors choose less aggressive prices, but still attract more likely public orders. Price competition is smoothed and expected market spreads widen. Promoting competition might be, however, enforced by (i) fine tuning through the degree of market transparency, (ii) favoring the entry of unpreferenced dealers, or (iii) requiring preferenced market-makers to have more funding capital.
Keywords: Preferencing, Internalization, Inventory management, Transparency
JEL Classification: D43, L21
Suggested Citation: Suggested Citation
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