The Journal of Finance

Trading Mechanisms in Securities Markets

Published: 06/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04403.x

ANANTH MADHAVAN

This paper analyzes price formation under two trading mechanisms: a continuous quote‐driven system where dealers post prices before order submission and an order‐driven system where traders submit orders before prices are determined. The order‐driven system operates either as a continuous auction, with immediate order execution, or as a periodic auction, where orders are stored for simultaneous execution. With free entry into market making, the continuous systems are equivalent. While a periodic auction offers greater price efficiency and can function where continuous mechanisms fail, traders must sacrifice continuity and bear higher information costs.

Discussion

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00376

Ananth Madhavan

Click or Call? Auction versus Search in the Over‐the‐Counter Market

Published: 03/26/2014   |   DOI: 10.1111/jofi.12164

TERRENCE HENDERSHOTT, ANANTH MADHAVAN

Over‐the‐counter (OTC) markets dominate trading in many asset classes. Will electronic trading displace traditional OTC “voice” trading? Can electronic and voice systems coexist? What types of securities and trades are best suited for electronic trading? We study these questions by focusing on an innovation in electronic trading technology that enables investors to simultaneously search many bond dealers. We show that periodic one‐sided electronic auctions are a viable and important source of liquidity even in inactively traded instruments. These mechanisms are a natural compromise between bilateral search in OTC markets and continuous double auctions in electronic limit order books.

An Analysis of Changes in Specialist Inventories and Quotations

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05122.x

ANANTH MADHAVAN, SEYMOUR SMIDT

We develop a dynamic model of market making incorporating inventory and information effects. The market maker is both a dealer and an investor, quoting prices that induce mean reversion in inventory toward targets determined by portfolio considerations. We test the model with inventory data from a New York Stock Exchange specialist. Specialist inventories exhibit slow mean reversion, with a half‐life of over 49 days, suggesting weak inventory effects. However, after controlling for shifts in desired inventories, the half‐life falls to 7.3 days. Further, quote revisions are negatively related to specialist trades and are positively related to the information conveyed by order imbalances.

The Relation between Stock Market Movements and NYSE Seat Prices

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00308

Donald B. Keim, Ananth Madhavan

Exchange seat prices are widely reported and followed as measures of market sentiment. This paper analyzes the information content of NYSE seat prices using: (1) annual seat prices from 1869 to 1998, and (2) the complete record of trades, bids and offers for the seat market from 1973 to 1994. Seat market volumes have predictive power regarding future stock market returns, consistent with a model where seat market activity is a proxy for unobserved factors affecting expected returns. We find abnormally large price movements in seats prior to October 1987, consistent with the hypothesis that seat prices capture market sentiment.

Competition and Collusion in Dealer Markets

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb03815.x

PRAJIT K. DUTTA, ANANTH MADHAVAN

This article develops a game‐theoretic model to analyze market makers' intertemporal pricing strategies. We show that dealers who adopt noncooperative pricing strategies may set bid‐ask spreads above competitive levels. This form of “implicit collusion” differs from explicit collusion, where dealers cooperate to fix prices. Price discreteness or asymmetric information are not required for collusion to occur. Rather, institutional arrangements that restrict access to the order flow are important determinants of the ability to collude because they reduce dealers' incentives to compete on price. Public policy efforts to increase interdealer competition should focus on such restrictions.

International Cross‐Listing and Order Flow Migration: Evidence from an Emerging Market

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00081

Ian Domowitz, Jack Glen, Ananth Madhavan

Policymakers in emerging markets are increasingly concerned about the consequences for the domestic equity market when companies list stock abroad. We show that the effects of cross‐listing depend on the quality of intermarket information linkages. We investigate these issues with unique data from the Mexican equity market. The impact of cross‐listing is complex—balancing the costs of order flow migration against the benefits of increased intermarket competition. These effects are exacerbated by equity investment barriers that induce segmentation of the domestic equity market. Consequently, the benefits and costs of cross‐listing are not evenly spread over all classes of shareholders.

Market Segmentation and Stock Prices: Evidence from an Emerging Market

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02725.x

IAN DOMOWITZ, JACK GLEN, ANANTH MADHAVAN

We examine the relationship between stock prices and market segmentation induced by ownership restrictions in Mexico. The focus is on multiple classes of equity that differentiate between foreign and domestic traders, and between domestic individuals and institutions. Significant stock price premia are documented for shares not restricted to a particular investor group. We analyze the theoretical and empirical determinants of premia across firms and over time. In addition to economy‐wide factors, segmentation reflects the relative scarcity of unrestricted shares. The results provide additional support for Stulz and Wasserfallen's (1995) hypothesis that firms discriminate between investor groups with different demand elasticities.