Market making, the tick size, and payment-for-order flow: theory and evidence

Article Abstract:

A study is conducted to examine the impact of a finite tick size and the practice of 'payment-for-order flow' on the competition between market-makers in the New York Stock Exchange (NYSE) and those in other stock exchanges. The results show that, because of payment-for-order flow, brokers may execute orders in the non-NYSE market even if these brokers carry out their fiduciary responsibility to get the most favorably quoted price for their customers. Orders may also migrate outside the NYSE even if NYSE market makers offer a lower reservation price. Empirical analysis indicates that specialists from other exchanges trade a bigger amount of the smaller order sizes and provide fewer opportunities for price improvements. Price improvements opportunities on the NYSE seem to have been made more attractive by large firms.

Securities & Commodities Exchanges, Securities and Commodity Exchanges, New York Stock Exchange, Securities dealers, Market makers (Securities trading)

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Options trading and the bid-ask spread of the underlying stocks

Article Abstract:

Options listings exert a distinct influence on the bid-ask spreads of underlying stocks. Using stock spread data from the New York Stock Exchange (NYSE), a meandecline in spreads was noted for options trading-associated spreads of stocks traded over-the-counter in the NYSE. Variations in volatility were noted for firms chosen for options listing. These volatility changes are observed to coexist with the said listing effect and are inferred to be probable causes of the stock exchange's listing of the stock. The possibility of misinformation developing from the options listing is also noted, such that misinformation results in a trade-off between increased liquidity advantages and information externalities, specifically that of financial market information costs.

Economic aspects, Stock options

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The behavior of volatility expectations and their effects on expected returns

Article Abstract:

The relationship between expectations of volatility and expectations of common stock returns is examined using implied volatilities from call options prices. An empirical model including lagged implied volatilities and other determinants is used to test the above relationship, as well as the effect of interest rates on implied volatilities. The results indicate that a positive relationship exists between returns volatility forecasts and recent stock and market volatilities. Stock returns are also positively affected by lagged values of implied volatilities. The study integrates existing theoretical and empirical work on the topic, while accounting for cross-sectional and serial correlation previously observed in implied volatilities.

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