Price Improvements in Financial Markets as a Screening Device

Thierry Foucault and Gabriel Desgranges

Working Papers from HAL

Abstract: In many security markets, market-makers offer to trade at a discount relative to their posted bid and ask quotes. In this article we provide an explanation to this phenomenon. We show that market-makers can mitigate informational asymmetries by selectively offering price improvements to their regular clients. We study a specific type of pricing strategy which consists (a) in offering price improvements to investors who have not repeatedly inflicted trading losses to the market-maker uses this pricing strategy, there are equilibria in which his clients optimally choose not to contact him when they have private information. These equilibria Pareto-dominate those which are obtained when the market-marker does not or can not make his quotes contingent on his clients' trading histories. Our Model predicts that (1) market-makers should grant price improvements to their regular clients but that (2) these improvements should be temporarily suspended after sequences of purchases (sales) followed by price increases (decreases).

Keywords: market design; Market microstructure; price improvements (search for similar items in EconPapers)
Date: 2011-06-04
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Published in 2011

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Working Paper: Price Improvements in Financial Markets as a Screening Device (2001)
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