Dealers and changing obligations: the case of stub quoting

Abstract

We examine the liquidity providing behavior of NASDAQ market makers surrounding two periods of changing dealer obligation. The first change in November, 2007 is the relaxation of rule 4613, which required NASDAQ market makers to place two-sided quotes “reasonably related” to the current best bid and offer. The relaxation of this rule permitted NASDAQ market makers to post quotes far away from the prevailing market, a practice frequently referred to as stub quoting. The second is the Securities and Exchange Commission ban on stub quoting in December, 2010, which requires market makers to quote within a predefined distance from market prices. We find evidence that placing restrictions on stub quoting alters market makers’ liquidity providing behavior in both the 2007 and 2010 rule change periods. Stub quoting restrictions increase the time that market makers quote at the NBBO. We also find evidence that the proportion daily volume executed by market makers increases during the 2007 stub quoting restriction. We also find evidence that restrictions on stub quoting narrows spreads and reduces the price impact of trades. However, we find little evidence that stub quoting rules impact the participation of market makers during days with excessive volatility.