Title

Investigating the quote decision behavior of the specialist and spread components between the options and underlying securities

Date of Award

1997

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Business Administration

Advisor(s)

Thomas Finucane

Keywords

stock market, spread components

Subject Categories

Economics | Finance

Abstract

This dissertation investigates the quote decision of the specialist in the stock market first, and then goes on to look at spread components between the options and their underlying securities.

We find that the quote decision of the specialist is affected by the information asymmetry and inventory control factors mentioned in previous research. In addition, the most recent trade has material effects on the quote decision of the specialist, while the trades with more than one lag have weak effects on the quote decision. This indicates that the specialist tends to adjust his quote to reflect the information, or to balance his inventory positions in a quick way. Besides, the specialist makes quotes depending on the trade size but not the dollar trade size.

For the quoted prices and sizes decision, the specialist tends to increase (decrease) the market liquidity when the information asymmetry decreases (increases). That is, the specialist chooses to decrease (increase) the ask (bid) price and increase the ask (bid) size simultaneously. Therefore, ignorance of the quoted sizes when investigating the market liquidity may give us a partial description of the liquidity condition in the market.

As for spread components, the stock market has higher information cost components at the opening and lower information cost components at the close. Consistent with the monopoly power hypothesis, higher inventory cost components and higher ordering cost components are present near the stock market closing. Furthermore, even though there are no strict patterns for the option spread components, higher inventory cost components near the options market closing suggest that competition between market makers causes higher inventory imbalance problems. Moreover, the stock market has higher information cost components, while the options market has higher inventory cost components and higher ordering cost components. This indicates that the stock market is more informative than the options market, and that the single dealer market comparatively has an advantage in processing and matching order flows. Besides, the order persistence phenomenon is present in the stock market, especially in the beginning of a trading day. This reflects that splitting of large orders prevails in the stock market.

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