Behavioral heterogeneity and financial markets: Locked/crossed quotes under informationally efficient pricing

Youzong Xu and Bo Li

Cogent Economics & Finance, 2017, vol. 5, issue 1, 1384524

Abstract: Market professionals and regulators have been concerned by locked/crossed quotes (negative quoted spreads) for years. To ease the concerns that locked/crossed quotes may cause confusion or instability in financial markets and to promote market efficiency, the Securities and Exchange Commission implemented rules that ban locked/crossed quotes. We consider a competitive financial market that does not contain the factors considered by market professionals and regulators consider as the origins of locked/crossed quotes. We find that if there are at least three types of traders in this financial market, locked/crossed quotes can arise naturally under efficient pricing. These locked/crossed quotes reflect information transmitted in financial markets, facilitating price discovery. Hence, regulations banning locked/crossed quotes are inappropriate, as these regulations may harm the efficiency of price discovery.

Date: 2017
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DOI: 10.1080/23322039.2017.1384524

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