Market Making with Costly Monitoring: An Analysis of the SOES Controversy

Thierry Foucault; Ailsa Röell; Patrik Sandås

doi:10.1093/rfs/hhg005

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Market Making with Costly Monitoring: An Analysis of the SOES Controversy

Thierry Foucault¹; Ailsa Röell^2,3; Patrik Sandås^2,4

¹ HEC Paris · ² Center for Economic and Policy Research · ³ Princeton University · ⁴ University of Pennsylvania

Review of Financial Studies 2003

This article presents a model of information monitoring and market making in a dealership market. We model how intensively dealers monitor public information to avoid being picked off by professional day traders when monitoring is costly. Price competition among dealers is hampered by their incentives to share monitoring costs. The risk of being picked off by the day traders makes dealers more competitive. The interaction between these effects determines whether a firm quote rule improves trading costs and price discovery. Our empirical results support the prediction that professional day traders prefer stocks with small spreads, but offer less support for the prediction that their trading leads to wider spreads.

DOI: 10.1093/rfs/hhg005
Volume: 16 (2)
Pages: 345-384
Language: en
Export: BibTeX
Sources: openalex crossref