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Paying for Market Quality

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Many financial markets, including electronic limit order markets, assign designated liquidity providers (LPs). We study the experience of the Stockholm Stock Exchange, where listed firms contract directly with LPs. Our analysis offers insights regarding situations where designated liquidity provision may be beneficial, and relating to the form of liquidity provision contracts, including the affirmative obligations required of the LP and compensation for LP services. We find that low current trading activity, wide spreads and higher information asymmetry increase the attractiveness of contracted liquidity provision. The evidence indicates that liquidity providers trade against market movements, and in times of wide spreads. On balance, firms contracting with LPs experience a decreased cost of capital, and significant improvements in market quality and price discovery.
OriginalsprogEngelsk
TidsskriftJournal of Financial and Quantitative Analysis
Vol/bind44
Nummer6
Sider (fra-til)1427-1457
ISSN0022-1090
DOI
StatusUdgivet - 2009

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