The Journal of Finance

Third Market Broker‐Dealers: Cost Competitors or Cream Skimmers?

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb03819.x

ROBERT H. BATTALIO

This article compares the bid‐ask spread for New York Stock Exchange (NYSE)‐listed securities before and after a major third market broker‐dealer, Bernard L. Madoff Investment Securities (Madoff), begins to selectively purchase and execute orders in those securities. Tests reveal the quoted bid‐ask spread tightens when Madoff enters the market. Furthermore, trading costs as measured by the difference between the transaction price and the midpoint of the contemporaneous bid‐ask spread do not increase. Together, these results suggest that the adverse selection problem associated with allowing agents to selectively execute orders in exchange‐listed securities may be economically insignificant.

Regulatory Uncertainty and Market Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets

Published: 11/14/2011   |   DOI: 10.1111/j.1540-6261.2011.01700.x

ROBERT BATTALIO, PAUL SCHULTZ

We examine how the September 2008 short sale restrictions and the accompanying confusion and regulatory uncertainty impacted equity option markets. We find that the short sale ban is associated with dramatically increased bid‐ask spreads for options on banned stocks. In addition, synthetic share prices for banned stocks become significantly lower than actual share prices during the ban. We find similar results for synthetic share prices of hard‐to‐borrow stocks, suggesting that the dislocation in actual and synthetic share prices is attributable to the increased hedging costs for options on banned stocks during the short sale ban.

Options and the Bubble

Published: 09/19/2006   |   DOI: 10.1111/j.1540-6261.2006.01051.x

ROBERT BATTALIO, PAUL SCHULTZ

Many believe that a bubble existed in Internet stocks in the 1999 to 2000 period, and that short‐sale restrictions prevented rational investors from driving Internet stock prices to reasonable levels. In the presence of such short‐sale constraints, option and stock prices could decouple during a bubble. Using intraday options data from the peak of the Internet bubble, we find almost no evidence that synthetic stock prices diverged from actual stock prices. We also show that the general public could cheaply short synthetically using options. In summary, we find no evidence that short‐sale restrictions affected Internet stock prices.

Can Brokers Have It All? On the Relation between Make‐Take Fees and Limit Order Execution Quality

Published: 05/23/2016   |   DOI: 10.1111/jofi.12422

ROBERT BATTALIO, SHANE A. CORWIN, ROBERT JENNINGS

We identify retail brokers that seemingly route orders to maximize order flow payments, by selling market orders and sending limit orders to venues paying large liquidity rebates. Angel, Harris, and Spatt argue that such routing may not always be in customers’ best interests. For both proprietary limit order data and a broad sample of trades from TAQ, we document a negative relation between several measures of limit order execution quality and rebate/fee level. This finding suggests that order routing designed to maximize liquidity rebates does not maximize limit order execution quality and thus brokers cannot have it all.

Reputation Effects in Trading on the New York Stock Exchange

Published: 05/08/2007   |   DOI: 10.1111/j.1540-6261.2007.01235.x

ROBERT BATTALIO, ANDREW ELLUL, ROBERT JENNINGS

Theory suggests that reputations allow nonanonymous markets to attenuate adverse selection in trading. We identify instances in which New York Stock Exchange (NYSE) stocks experience trading floor relocations. Although specialists follow the stocks to their new locations, most brokers do not. We find a discernable increase in liquidity costs around a stock's relocation that is larger for stocks with higher adverse selection and greater broker turnover. We also find that floor brokers relocating with the stock obtain lower trading costs than brokers not moving and brokers beginning trading post‐move. Our results suggest that reputation plays an important role in the NYSE's liquidity provision process.

Toward a National Market System for U.S. Exchange–listed Equity Options

Published: 03/25/2004   |   DOI: 10.1111/j.1540-6261.2004.00653.x

Robert Battalio, Brian Hatch, Robert Jennings

In its response to the 1975 Congressional mandate to implement a national market system for financial securities, the Securities and Exchange Commission (SEC) initially exempted the option market. Recent dramatic changes in the structure of the option market prompted the SEC to revisit this issue. We examine a sample of actively traded, multiply listed equity options to ask whether this market's characteristics appear consistent with the goals of producing economically efficient transactions and facilitating “best execution.” We find marked changes between June 2000, when quotes are often ignored, and January 2002, when the market more closely resembles a national market.