Transparency Matters: Price Formation in Presence of Order Preferencing

47 Pages Posted: 26 Oct 2006 Last revised: 14 Jan 2014

See all articles by Laurence Daures

Laurence Daures

ESSEC Business School

Christian Y. Robert

CNAM, Conservatoire des Arts et Metiers

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

Daures, Laurence and Robert, Christian Y., Transparency Matters: Price Formation in Presence of Order Preferencing (October 1, 2011). Journal of Financial Markets, Forthcoming, EFA 2007 Ljubljana Meetings Paper, Available at SSRN: https://ssrn.com/abstract=940389 or http://dx.doi.org/10.2139/ssrn.940389

Laurence Daures (Contact Author)

ESSEC Business School ( email )

3 Avenue Bernard Hirsch
CS 50105
CERGY, CERGY PONTOISE CEDEX 95000
France
+33 1 34 43 33 62 (Phone)
+33 1 34 43 32 12 (Fax)

Christian Y. Robert

CNAM, Conservatoire des Arts et Metiers ( email )

292, rue Saint-Martin
Paris cedex 03, 75141
France

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