The Market Quality of Dealer versus Hybrid Markets: The Case of Moderately Liquid Securities

Abstract

Over the last decade, electronic limit-order trading systems have been sweeping securities exchanges around the world. This paper studies a transitional case, namely, the commencement of trading of a group of moderately liquid stocks on SETS of the London Stock Exchange. The evidence reveals that the liquidity of those stocks dropped substantially after the introduction of the limit order book and the removal of the market makers' obligations. This transition provides an example that a hybrid market with a limit order book and voluntary dealers may not perform as well as a dealership market with obligatory market makers. Copyright 2007 The Author Journal compilation (c) 2007 Blackwell Publishing Ltd.

Order Imbalance in the FTSE Index Futures Market: Electronic versus Open Outcry Trading

“…However, some literatures suggest that a pure limit order system may perform poorly for the thinly traded securities. Using data of the less liquid FTSE Mid-250 stocks from London Stock Exchange,Lai (2007) shows C 2008 The Authors Journal compilation C Blackwell Publishing Ltd. 2008…”

Idiosyncratic risk, returns and liquidity in the London Stock Exchange: A spillover approach

“…The introduction of the SETS was expected to increase liquidity since the competition among the dealers was expected to reduce transaction costs and thus increase liquidity and trading activity. On the other hand, the absence of the obligation of market makers to provide quotes -as was the institutional framework in a quote-driven market like the SEAQwould decrease the stability of the trading system and would lead to increased volatility (Lai, 2007). Empirical evidence on the LSE market reform has not yet fully supported the prospects of increased liquidity: Gajewski and Gresse (2007), Lai (2007) and Giouvris and Philippatos (2008) present evidence of reduced liquidity under the SETS and its hybrid microstructure features.…”

“…Empirical evidence on the LSE market reform has not yet fully supported the prospects of increased liquidity: Gajewski and Gresse (2007), Lai (2007) and Giouvris and Philippatos (2008) present evidence of reduced liquidity under the SETS and its hybrid microstructure features. the effect of the transition from the SEAQ to the SETS (Taylor, van Dijk, Franses, & Lucas, 2000;Chelley-Steeley, 2005;Ellul, Shin, & Tonks, 2005;Lai, 2007;Galariotis & Giouvris, 2007a), iv) the characteristics of the interdealer market (Hansch, Naik, & Viswanathan, 1998;Reiss & Werner, 1998;Reiss & Werner, 2005), and v) the characteristics of large trades (Gemmil, 1996;Snell & Tonks, 2003;Bernhardt, Dvoracek, Huhgson, & Werner, 2005).…”

The Role of Pre‐Existing Liquidity in Determining Pricing Efficiency and Liquidity Gains Following the Introduction of SETSmm

“…At the time SETS was introduced a call auction opened the market and continuous trading took place until the market closed. In 1999 the most liquid FTSE 250 stocks were also placed on SETS, Lai () reports a rise in adverse selection following migration for these firms as evidenced by a rise in the realised and effective spread. To improve liquidity at the close a closing auction was introduced in May 2000, Ellul et al .…”

“…At the time SETS was introduced a call auction opened the market and continuous trading took place until the market closed. In 1999 the most liquid FTSE 250 stocks were also placed on SETS, Lai (2007) reports a rise in adverse selection following migration for these firms as evidenced by a rise in the realised and effective spread. To improve liquidity at the close a closing auction was introduced in May 2000, Ellul et al (2005) show that the closing call provides more efficient price discovery than the alternative dealer system but despite this significant amounts of order flow was still directed through dealers, especially if firms were less liquid.…”