Quotes, Trades and the Cost of Capital

Ioanid Rosu, Elvira Sojli and Wing Wah Tham
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Ioanid Rosu: GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique

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Abstract: We study how market makers set their quotes in relation to trading, liquidity, and expected returns. In our model, market makers in neglected, difficult-to-understand stocks monitor the market more often, thus increasing their quote-to-trade (QT) ratio. They also monitor more often when their clients are more precisely informed, which reduces mispricing and lowers expected returns. Consistent with our model, large QT ratios are empirically associated with low expected returns, a result driven by quotes, not by trades. Moreover, more market makers are associated with smaller QT ratios, but have no effect on the cost of capital.

Keywords: Quote-to-trade ratio; market making; liquidity; price discovery; monitoring; information acquisition; neglected stocks; inventory; high frequency trading (search for similar items in EconPapers)
Date: 2017-07-24
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Working Paper: Quotes, Trades and the Cost of Capital (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:wpaper:hal-01941510

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