Price Experimentation and Security Market Structure

J Chris Leach and Ananth Madhavan

The Review of Financial Studies, 1993, vol. 6, issue 2, 375-404

Abstract: We examine the role of market makers in facilitating price discovery. We show that a specialist may experiment with prices to induce more informative order flow, thereby expediting price discovery. Market makers in a multiple-dealer system, unlike a specialist system, do not have the incentives to perform such costly experiments because of free-rider problems. Consequently, the specialist system may provide open markets where bid-ask spreads. We analyze the effect of experimentation on the bid-ask spread and provide an exploratory analysis of intraday specialist data that is consistent with our price experimentation hypothesis. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Date: 1993
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