Designated Market Makers Research Articles

Designated market makers and agricultural futures market quality: Evidence from China's Dalian commodity exchange

AbstractMany financial markets use designated market makers (DMMs), but the impacts of DMMs on agricultural futures markets – and in particular, how to arrange DMMs among contracts expiring in different months – are largely neglected. In 2017, Chinese exchanges started recruiting DMMs for inactive contracts when they become nearby contracts to address the discontinuous trading activity of nearest‐to‐maturity contracts, which enables us to study the benefit and cost of recruiting DMMs for inactive contracts using a quasi‐experimental framework. Leveraging tick‐by‐tick data on corn and soybean meal futures, we find that DMMs improve the market quality of inactive contracts without disrupting the market quality of dominant contracts. Heterogeneity analysis in policy settings suggests that more DMMs are conducive to improving market quality for corn and soybean meal futures. We demonstrate that DMM policy is a feasible measure to facilitate continuous activeness in Chinese agricultural futures markets. Our results are important for exchanges and regulators seeking to better design and implement designated market‐making programs in agricultural futures markets.

The impact of designated market-makers on liquidity in frontier markets

Many exchanges around the globe have implemented market-making schemes inan attempt to mitigate liquidity risk and enhance trading volume. This researchexamines the impact of designated market makers on stock liquidity in frontiermarkets, specifically measured by bid-ask spreads and trading turnover. Using adifference-in-differences analysis, we studied 19 stocks that introduced designatedmarket makers at the Zagreb Stock Exchange and Ljubljana Stock Exchangebetween May 2010 and January 2022. To the best of our knowledge, this is the firststudy investigating the impact of market makers in these specific markets and onlythe second in frontier markets overall. As expected, we find a significant reductionin bid-ask spreads for most stocks following the introduction of market makers.However, unlike findings of studies conducted in more developed markets, ourresults for turnover are not conclusive, suggesting that market makers alone maynot be sufficient to overcome structural impediments to market liquidity in frontiermarkets, such as lack of free float and the dominance of large investors with long-term investment horizons.

Market Liquidity and Competition Among Designated Market Makers

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? We employ data from NYSE Euronext Paris to show that exogenous changes in contract design lead to significant decreases in quoted and effective spreads. In particular, market liquidity increases the most for stocks with the largest increase in competition among DMMs. Our analysis shows that competition among DMMs is an important aspect of contract design, along with elements such as rebates and requirements. This paper was accepted by Kay Giesecke, finance. Funding: M. G. Subrahmanyam thanks the Alexander von Humboldt Foundation for generous financial support via the Anneliese Maier Award. L. Pelizzon thanks the Leibniz Institute for Financial Research SAFE for financially sponsoring this research and Italian Ministry for University and Research [MIUR–2017RSMPZZ]. This work was also supported by the Deutsche Forschungsgemeinschaft [Grant 329107530]. Supplemental Material: The Internet Appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01801 .

One for the money, two for the show? The number of designated market makers and liquidity

One for the money, two for the show? The number of designated market makers and liquidity

Utilization of Weekly Options for the Improvement of the Volatility Index

As the liquidity of KOSPI 200 index options is concentrated on the nearest expiration contract, the V-KOSPI 200 index, which is based on near- and next-term months options, fluctuates abnormally, and the designated market makers of V-KOSPI 200 futures suffer from hedging their inventory positions. This study suggests the volatility index, which includes KOSPI 200 weekly options instead of next-term monthly options. The index can mitigate rare spikes and the low volatility of the V-KOSPI 200 index, which mainly arise from stale market prices and low-frequency trading in the second and third contract months. The empirical results show that the monthly trading volume of weekly options more than triples compared to second- and third-contract month options, and the microstructure of both markets is roughly similar. The trading frequency of weekly options is six times higher than that of next-term monthly options. Therefore, V-KOSPI 200 futures market makers can use weekly options traded more actively instead of second-month options as components of hedging portfolios, while helping the new volatility index mitigate the abnormal fluctuation of the V-KOSPI 200 index.

Who moved my liquidity? Liquidity evaporation in emerging markets in periods of financial uncertainty

We investigate the role of different types of investors, foreigners, institutions, and individuals on the loss of liquidity in seven emerging markets during periods of global financial uncertainty from 2008 to 2016. We find that net sales from foreigners are the main driver of liquidity loss. Using TAQ data from one market, we find that active sales of foreigners erode liquidity, whereas some individuals act as the liquidity providers of last resort. We find no consistent role for institutions. These results highlight the importance of retail investors as liquidity providers in markets without designated market makers.

Preopening price indications and market quality: Evidence from NYSE Rule 48

AbstractIn this article, we explore the role of preopening price signals in price discovery and liquidity. NYSE Rule 48 suspends the responsibility of designated market makers for disseminating preopening price indications in the event of extreme marketwide volatility. Rule 48 speeds up the opening of stocks at the expense of lower liquidity. The absence of preopening price indications results in reduced liquidity during the first 30 min of the trading day. We interpret this finding as evidence that liquidity suppliers are less willing to provide liquidity in the absence of a reference point or benchmark regarding stock value.

Effect of KRX Designated Market Maker on Liquidity

The transformation of order-driven markets into a hybrid market by introducing market makers reflects the global trend to increase market quality factors, such as liquidity. This study evaluates how market makers influence liquidity, using the data on market maker-designated stocks collected in 2020. The analysis of the effectiveness of the market maker and significance of individual stock-level liquidity shows that the effect of newly designated stocks is higher than that of undesignated stocks. The study finds that the effect of increasing the stock liquidity of consecutively designated market makers is lower than that of the newly designated market makers; in particular, the effect of increased liquidity dominated the effect of the entire sample period during which short selling was banned. These empirical findings are interpreted as the effect of funds inflow, which occurred due to the monetary policies adopted and prohibition of short selling by financial authorities during the coronavirus disease 2019 pandemic, combined with the liquidity provision of market makers. Overall, we compare the level of liquidity in the stocks designated by market makers to highly liquid stocks; the market maker’s role is assessed to have an effect on liquidity.

Do Designated Market Makers Facilitate Price Informativeness? Evidence from Earnings Announcements

Do Designated Market Makers Facilitate Price Informativeness? Evidence from Earnings Announcements

One for the Money, Two for the Show?The Number of Designated Market Makers and Liquidity

One for the Money, Two for the Show?The Number of Designated Market Makers and Liquidity

One for the Money, Two for the Show?The Number of Designated Market Makers and Liquidity

One for the Money, Two for the Show?The Number of Designated Market Makers and Liquidity

Large-caps liquidity provision, market liquidity and high-frequency market makers’ trading behaviour

This paper exploits the introduction of the liquidity provision scheme (LPS) in NASDAQ Stockholm (NOMX) to assess how the implementation of LPS affects market liquidity and the trading behaviors of high-frequency market makers. Unlike the traditional designated market makers (DMM) that target the liquidity supply of small and less traded stocks, LPS is implemented for large-caps and liquid stocks. LPS requires participants to submit buy and sell orders at the European best bid and offer quotes with a size larger than 50,000 Swedish Krona on each trade side. LPS delivers liquidity improvements by reducing order processing costs in the large-cap and cross-listed stocks in the NOMX and Chi-X markets, with no evidence of market liquidity migration from Chi-X to NOMX. As market makers registered with LPS are likely high-frequency traders, LPS stabilizes market liquidity as market makers’ decisions to supply or demand liquidity become less sensitive to market conditions like the spread and order imbalance.

The Effect of Designated Market Makers on Market Volatility: Evidence from a Natural Experiment

Designated market makers (DMMs) are utilized in many stock markets to provide liquidity and to reduce volatility, but convincing evidence regarding their effects on volatility is scarce. We estimate the effects of DMMs on securities by exploiting exogenous variation in DMM assignment to securities generated by a cutoff rule in the eligibility criteria of securities for DMM designation in the Korean Stock Exchange market. Using a regression discontinuity design, we find that DMMs not only improve the liquidity of securities but that they also increase return volatility. We investigate potential channels for the DMM-induced volatility increase and find evidence suggesting that it is a consequence of increased presence of funds whose managers, as previous studies suggest, engage in noise trading.

Call of Duty: Designated Market Maker Participation in Call Auctions

Many equity markets combine continuous trading and call auctions. Oftentimes designated market makers (DMMs) supply additional liquidity. Whereas prior research has focused on their role in continuous trading, we provide a detailed analysis of their activity in call auctions. Using data from Germany’s Xetra system, we find that DMMs are most active when they can provide the greatest benefits to the market, i.e., in relatively illiquid stocks and at times of elevated volatility. Their trades stabilize prices and they trade profitably.

Stock Liquidity and Algorithmic Market Making During the COVID-19 Crisis

Much of the liquidity supply in modern markets comes from algorithmic traders (ATs). Prompted by concerns of fragility induced by such voluntary market making, we examine ATs’ liquidity-provision role during the COVID-19 crisis. We find that amidst the turmoil as market liquidity declined ATs did not (disproportionately) withdraw liquidity supply. Stocks with the highest algorithmic trading (AT) experienced lower liquidity reduction compared to stocks with the lowest AT activity. High AT stocks did not experience greater reduction in either competition for liquidity provision or price improvements than low AT stocks. Multiple tests indicate that high AT did not associate with any greater deterioration in price efficiency vis-à-vis low AT stocks. Stocks in the industries hardest hit by COVID-19 did not see any less AT competition for liquidity supply or price efficiency than stocks in the least affected ones. Overall, our results allay some concerns that the current levels of AT make markets more susceptible to liquidity withdrawal in times of crises.

Call of duty: Designated market maker participation in call auctions

Many equity markets combine continuous trading and call auctions. Oftentimes designated market makers (DMMs) supply additional liquidity. Whereas prior research has focused on their role in continuous trading, we provide a detailed analysis of their activity in call auctions. Using data from Germany's Xetra system, we find that DMMs are most active when they can provide the greatest benefits to the market, i.e., in relatively illiquid stocks and at times of elevated volatility. Their trades stabilize prices and they trade profitably.

고빈도 경쟁시장에서 시장조성자제도의 의무ㆍ보상기준 개선방향

고빈도 경쟁시장에서 시장조성자제도의 의무ㆍ보상기준 개선방향

The Microstructure of Endogenous Liquidity Provision

We analyze a nonlinear rational expectations equilibrium model with an ex post endogenous liquidity provision decision. Speed and information technology advantages allow endogenous liquidity providers (ELPs) to switch between limit and market orders after observing private information. This significantly influences the adverse selection faced by designated market makers (DMMs), thereby generating a gap between liquidity supply from DMMs and liquidity demand by informed traders. As a result, endogenous liquidity provision leads to two equilibrium regimes with nonlinear price impacts and the possibility of market breaks. These breaks occur when ELPs switch from liquidity provision to liquidity consumption as a consequence of unexpected shocks. Increasingly similar information among ELPs reduces the risk of systematic liquidity withdrawals but intensifies the DMMs’ adverse selection cost. Our model is relevant to various plausible settings and can help to explain a variety of financial market outcomes.

Pre-Opening Price Indications and Market Quality

This paper explores the role of pre-opening price signals in price discovery and liquidity by analyzing the effect of Rule 48 on stock opening delay and various measures of liquidity. NYSE Rule 48 suspends the responsibility of designated market makers for disseminating pre-opening price indications in the event of extreme market-wide volatility. We show that Rule 48 speeds up the opening of stocks at the expense of lower liquidity. Specifically, the absence of pre-opening price indications results in decreases in various measures of liquidity during the first 30-minutes of the trading day that are statistically and economically significant. We interpret this finding as evidence that liquidity suppliers are less willing to provide liquidity in the absence of a reference point or benchmark regarding the value of a stock.

Paying for Market Liquidity: Competition and Incentives

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from the NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in the realized spread. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our analysis shows that incentivizing DMMs might not necessary lead to an improvement of market liquidity unless exchanges induce greater competition among DMMs.