DO DEALERS INFER INFORMATION FROM ORDER FLOW?
In: The journal of financial research: the journal of the Southern Finance Association and the Southwestern Finance Association, Volume 30, Issue 2, p. 181-200
ISSN: 1475-6803
AbstractI examine strategic behavior among dealers in the NASDAQ market and document that there is a lead quote‐setting dealer in each security and that the quotes posted by this leader are informative. Other dealers free‐ride this information by following the lead quote‐setting dealer. The lead dealer can be identified by two information signals: (1) percentage of time spent on the inside market (i.e., posting inside quotes), and (2) trade volume transacted. Dealers that free‐ride the leader's quotes quickly update their posted quotes in the same direction as the leader's quote change. My findings suggest that directing trade to the lead dealer may be more advantageous than randomly routing trade.