Can quote competition reduce preferenced trading? A reexamination of the SEC's 1997 order handling rules

S. Ghon Rhee, Ning Tony Tang

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Abstract

In 1997, the SEC implemented the new order handling rules (OHRs) on the NASDAQ. We observe that some uncompetitive positions gained market share without improving quote competitiveness after the implementation of the OHRs. Also observed is a significant decline in the sensitivity of trading volume to quote competitiveness, indicating lower incentive for NASDAQ dealers to engage in quote competition in the post-OHR regime. We find that positions that gained trading volume without improving quote competitiveness were less competitive and were more closely associated with stocks showing low information asymmetry, which suggests that preferenced trading might be responsible for the decline in the trading volume sensitivity. Examining entries and exits around the periods of adopting OHRs, we observe net entry of uncompetitive positions and net exit of competitive positions, which indicates that preferenced trading crowded out quote competition subsequent to the OHRs. Our findings suggest that forcing intense quote competition alone produced an unwanted effect that preferencing emerged as a more attractive alternative to quote competition.

Original languageEnglish
Pages (from-to)243-264
Number of pages22
JournalAccounting & Finance
Volume53
Issue number1
DOIs
Publication statusPublished - Mar 2013
Externally publishedYes

Keywords

  • G18
  • G28
  • Market reforms
  • Order flow competition
  • Order handling rules
  • Preferenced trading
  • Quote competitiveness

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