Managerial Ecomony - Week 6 - Case Study Nasdaq

Case study - NASDAQ

Thinh, Vu Q

tvu0193@student.bristoluniversity.edu

Bristol University

BUS 525 (A): Managerial Economy

9-Apr-2014

Case Summary

The National Association of Securities Dealers Automated Quotations, or more commonly known as NASDAQ, is the world’s largest electronic stock exchange and has more trading volume than any stock exchange in the world. The exchange operates via securities dealers, or “market makers”, who simultaneously quote a bid price they are willing to buy a stock for, and an ask price they are willing to sell a stock for. In every NASDAQ listed company there are at least two dealers who compete to offer the best bid and ask price to investors who are looking to buy or sell a stock. The difference between the dealers’ bid price and ask price is known as the “dealer spread” and represents the dealers profit.

NASDAQ’s quotes are constantly updated through the computerized quotation system with each dealers bid and ask prices for each particular stock. The highest bid price quoted is referred to as the ‘inside bid’, and the lowest ask price quoted is referred to as the ‘inside ask’. The difference between the two is known as the ‘inside spread’. The greater the ‘inside spread’ the greater the profits for dealers, and therefore the greater transaction costs that must be borne by investors. In 1994, a pair of economists released a study that indicated that NASDAQ dealers were colluding amongst themselves by intentionally only quoting bid and ask prices in “even-eights”, thereby insuring that the ‘inside spread’ was a minimum of ¼ point (or $0.25), even though they could quote in 1/8 increments. In order to keep the collusion work, market makers have enforced the quoting conventions through peer pressure by making it known that violating the conventions was “unethical” or “unprofessional,” and that the market makers allegedly threatened to refuse to deal with traders who violated the conventions.

What role...