To Trade or Not to Trade: The Effect of Broker Search and Discretionary Trading on Securities Market Performance

Authors: Zhang W.¹; Li J.²; Wu C.³

Source: The Financial Review, Volume 39, Number 2, May 2004 , pp. 271-292(22)

Publisher: Blackwell Publishing

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Abstract:

In this article we examine the interaction of brokerage search with the Bayesian learning behavior of competitive dealers under asymmetric information. We particularly focus on the effects of price search and discretionary trading on the performance of a dealer market. A search process is incorporated into a model in which brokers determine their reservation price and whether to continue their trades. The model enables us to uncover the interrelationships among search cost, bid-ask spread, and price volatility. We show that both spread revision and price volatility are dependent upon the optimal search process, inventory fluctuation, and search cost. Furthermore, our model predicts a negative relationship between price volatility and liquidity trading volume.

Keywords: search; price dispersion; trading costs; G20

Document Type: Research article

DOI: 10.1111/j.0732-8516.2004.00076.x

Affiliations: 1: State University of New York–Fredonia 2: Northeastern University 3: Syracuse University