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Financial Markets and Portfolio Management

Erschienen in:

20.02.2020

Which firms benefit from market making?

verfasst von: Y. Peter Chung, S. Thomas Kim, Kenji Kutsuna, Richard L. Smith

Erschienen in: Financial Markets and Portfolio Management | Ausgabe 1/2020

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Abstract

From 1998 until 2008, all firms on the JASDAQ exchange could choose and switch between a market-maker method similar to NASDAQ and a continuous auction method similar to NYSE for trading their shares. We find that selecting a more suitable trading method increases firm value. When low-liquidity firms switched to market making, their liquidity improved, while high-liquidity firms switched to auction despite modest but significant decreases in liquidity. The results suggest that though market making is costly, it is valuable for firms as long as the liquidity benefits are sufficient to justify the implicit intermediation fee.

Vorheriger Artikel Aggregate insider trading and the prediction of corporate credit spread changes

Nächster Artikel The stock market’s reaction to macroeconomic news under ambiguity

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The difference between NYSE and NASDAQ has decreased in recent years, but the NYSE is still an auction market, generally with a single liquidity provider, while the NASDAQ is a dealer market where securities have multiple market makers who can buy and sell for their own account (principal trades) and for client accounts (agency trades). The NASDAQ introduced a compensated designated liquidity provider program for certain low-trade-volume securities in 2007.

For a brief history of JASDAQ, see https://www.jpx.co.jp/english/corporate/about-jpx/history/02-02.html.

When, on March 18, 2008, JASDAQ announced its intent to discontinue the MM method, the exchange indicated that a limited number of issues were being traded via MM and that consequently, after March 24, all issues would trade by Auction using the Liquidity Provider System that currently is in use (Bank of Tokyo-Mitsubishi UFJ, Ltd. Press release, March 18, 2008). JASDAQ became a part of the Osaka Securities Exchange (OSE) in 2010 and the OSE merged with the Tokyo Stock Exchange (TSE) in 2013. Since the merger, all JASDAQ shares have been traded through continuous auctions. See Uno et al. (2002) for details on the historical choices of the trading method on JASDAQ.

If there was insufficient interest in a stock to attract at least two market makers, the firm was required to resort to Auction.

A securities firm that received both buy and sell orders could cross the orders without using a market maker as long as the trade price was within the inside spread. See Uno et al. (2002).

Even in Auction there can be dealers who seek to earn the spread by providing liquidity. They are, however, under no obligation to post a bid and ask quote or act as a buyer or seller of last resort.

No previous study, to our knowledge, has focused directly on the relationship between the firm’s choice of trading method and the characteristics and value of the firm.

In 2004, JASDAQ mandated the MM method for IPO firms with fewer than 600 shareholders. However, the number 600 was too small to be binding, and therefore, all firms were able to freely choose between the two trading methods. See Inoue (2006).

Dual listing does not provide a clean experiment of the relative benefits of MM and auction since there can be arbitrage across the exchanges, and the better exchange can be selected for each trade. For example, continuous auction trading on the NYSE could be fine for a dual-listed firm since an investor could use NASDAQ for liquidity.

The NPM data were originally created by Nikkei. Financial Data Solutions, Inc., purchased the right to distribute the data, and has been updating and managing the data.

During the sample period, JASDAQ stopped providing market making service when a firm was unable to attract at least two market makers or was otherwise unable to meet listing requirements. Since we seek to capture only voluntary switches, we exclude 94 cases where a firm is switched from MM to Auction within 6 months prior to being delisted. We assume that switches to Auction within 6 months of delisting are not voluntary.

We also tested event windows that provide for delayed stock price reactions or public announcements (− 10, + 10). Results are qualitatively similar to those in Table 2.

We obtain qualitatively similar results for other time intervals before and after the switch, such as 60 days or 180 days.

See, for example, Anderson and Dyl (2007).

From the 344 and 257 switches reported in Table 1, we lose 22 and 13, respectively, due to missing data.

We have also formed liquidity-based portfolios using the Amihud illiquidity measure and have implemented a double sort where we sort first by market value and second by the ZEROs measure or the Amihud measure. Results are similar to those reported in Table 5 and are available on request.

We thank Jun Uno for obtaining these data and sharing them with us.

As an alternative to measuring MM Propensity as a ratio, we also measure it as the difference between the number of MM and Auction IPOs over the 60 market days prior to the IPO. Results are similar to those reported in Table 8 for the ratio measure and are available from the authors on request.

Wooldridge (2001) specifies the use of probit. The logit results reported in Table 8 and probit results used to construct the variable in Table 9 are virtually identical except for scaling. Logit and probit yield similar results in Table 9.

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Titel: Which firms benefit from market making?
verfasst von: Y. Peter Chung
S. Thomas Kim
Kenji Kutsuna
Richard L. Smith
Publikationsdatum: 20.02.2020
Verlag: Springer US
Erschienen in: Financial Markets and Portfolio Management / Ausgabe 1/2020
Print ISSN: 1934-4554
Elektronische ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-020-00345-5

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