Liquidity and Competition in Unregulated Markets
ABSTRACT Despite reputedly widespread market manipulation and insider trading, we find surprisingly high liquidity and low transactions costs for actively traded securities on the NYSE between 1890 and 1910, decades before SEC regulation. Moreover, market makers behave largely as predicted in theory: stocks with liquid markets and competitive market makers (cross-trading at the rival Consolidated Exchange) trade with substantially lower quoted bid-ask spreads and with less anti-competitive behavior (price discreteness). Effective spreads, illiquidity, and volume all improve monotonically over time. Notably, the asymmetric information component of effective spreads increases in relative and absolute terms from 1900 to 1910.
- Journal of Law and Economics. 02/1992; 34(2):591-644.
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ABSTRACT: Most economic models of asset pricing assume that the impact of transac- tion costs on pricing is minor. Although this is arguable and relmains, em- pirically, an open question, most investors consider transaction costs very important in making portfolio management decisions. This may largely ex- plain the substantialinterest in 'microstructure' models of the bid/ask spread. One such model is the asymmetric information model. This model breaks the spread into two components. The first allows market-makers to generate revenue from a seemingly random order flow to cover inventory costs, clearing fees, and/or monopoly profits. This component may be called the transitory component, since its effect on stock price time series is unrelated to the underlying value of the securities. The second component arises because market-makers may trade with unidentified investors who have superior infor- mation. When such asymmetric information exists, informed traders profit by