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Preferencing, internalization and inventory position

Laurence Daures Lescourret and Christian Y. Robert ()
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Christian Y. Robert: Ecole Nationale de la Statistique et de l’Administration Economique (ENSAE), Postal: 15 Boulevard Gabriel Peri, 92245 MALAKOFF, FRANCE

No DR 06017, ESSEC Working Papers from ESSEC Research Center, ESSEC Business School

Abstract: We present a model of market-making in which dealers differ by their current inventory positions and by their preferencing agreements. Under preferencing, dealers receive captive orders that they guarantee to execute at the best price. We show that preferencing raises the inventory holding costs of preferenced dealers. In turn, competitors post less aggressive quotes. Since price-competition is softened, expected spreads widen. The entry of unpreferenced dealers, or the ability to route preferenced orders to best-quoting dealers, as internalization does restore price competitiveness. We also show that a greater transparency may negatively affect expected spreads, depending on the scale of preferencing.

Keywords: Internalization; Inventory Control; Market Microstructure; Preferencing; Transparency (search for similar items in EconPapers)
JEL-codes: D43 L21 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2006-11
New Economics Papers: this item is included in nep-bec, nep-cse and nep-mst
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