NASDAQ Market Research Articles

The Declining Role of NASDAQ Market Makers

AbstractWe compare the liquidity providing behavior of NASDAQ market makers in 2010 to their behavior in 2004. We examine how frequently market makers are at the inside quote, what market and stock specific factors influence market makers’ behavior, and the relation between market maker participation and intraday bid‐ask spread patterns. We observe a decrease in the percent of the trading day dealers’ quote at the inside, a decline in the number of market makers, and a decrease in the influence market makers have on intraday spread patterns. The results suggest that the role of NASDAQ market makers declines over time.

Dealers and Changing Obligations: The Case of Stub Quoting

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 stub quoting restrictions increase the proportion of daily volume executed in the 2007 time period by market makers. However, we find little evidence that stub quoting rules impact the participation of market makers during days with excessive volatility.

A Standardized Normal-Laplace Mixture Distribution Fitted to Symmetric Implied Volatility Smiles

This article proposes to use a standardized version of the normal-Laplace mixture distribution for the modeling of tail-fatness in an asset return distribution and for the fitting of volatility smiles implied by option prices. Despite the fact that only two free parameters are used, the proposed distribution allows arbitrarily high kurtosis and uses one shape parameter to adjust the density function within three standard deviations for any specified kurtosis. For an asset price model based on this distribution, the closed-form formulas for European option prices are derived, and subsequently the volatility smiles can be easily obtained. A regression analysis is conducted to show that the kurtosis, which is commonly used as an index of tail-fatness, is unable to explain the smiles satisfactorily under the proposed model, because the additional shape parameter also significantly accounts for the deviations revealed in smiles. The effectiveness of the proposed parsimonious model is demonstrated in the practical examples where the model is fitted to the volatility smiles implied by the NASDAQ market traded foreign exchange options.

Spin glasses and nonlinear constraints in portfolio optimization

We discuss the portfolio optimization problem with the obligatory deposits constraint. Recently it has been shown that as a consequence of this nonlinear constraint, the solution consists of an exponentially large number of optimal portfolios, completely different from each other, and extremely sensitive to any changes in the input parameters of the problem, making the concept of rational decision making questionable. Here we reformulate the problem using a quadratic obligatory deposits constraint, and we show that from the physics point of view, finding an optimal portfolio amounts to calculating the mean-field magnetizations of a random Ising model with the constraint of a constant magnetization norm. We show that the model reduces to an eigenproblem, with 2N solutions, where N is the number of assets defining the portfolio. Also, in order to illustrate our results, we present a detailed numerical example of a portfolio of several risky common stocks traded on the Nasdaq Market.

Information asymmetry and accounting restatement: NYSE-AMEX and NASDAQ evidence

We examine the impact of accounting restatement announcement on firms’ value and information asymmetry for both auction market (NYSE-AMEX) and dealer market (NASDAQ) using a public sample of restatement announcements from 1997 to 2005. In both markets, we document economically and significantly negative mean cumulative abnormal returns around the announcement dates. The restatements attributed to auditors are associated with more negative returns than those attributed to management and the SEC. However, there is no significant difference between market reactions arising from the core and non-core restatements. We also find a significant increase in volume, number of transactions, average order size, volatility, and various measures of spreads after the restatement announcement indicating that restatement announcements diminish company prospects and contribute to increased uncertainty and information asymmetry. Finally, we find that the information asymmetry in the NASDAQ market around the event date is less pronounced than in the NYSE-AMEX market.

Are Negative P/E and P/B ratio Firms Different?

Using separately AMEX, NASDAQ and NYSE stock market data for the period 1968-2011, the purpose of this paper is to examine whether negative multiple firms are different from positive ones by examining the performance of negative P/E or P/B firms and how this performance compared with the most widely examined positive multiples firms. We find that firms with negative multiples are indeed different than firms with positive in that (a) a relatively small number of firms with negative multiples experience high forward stock returns even though the majority of them does not resulting in a large difference between mean and median returns and (b) the small firm-low liquidity effect observed in positive multiple firms is not as clearly observed in the case of negative multiple firms. This indicates that prior academic research was right in excluding negative multiple firms from their analysis as inclusion would have affected the homogeneity of their sample and would have diluted their findings and tests of significance.

A clustering approach to examine the dynamics of the NASDAQ topology in times of crisis

Article history: Received May 15, 2012 Accepted 8 June 2012 Available online June 9 2012 This paper investigates the dynamics of the NASDAQ topology before, during, and after 2008 financial crisis. First, multiresolution analysis by virtue of wavelet transform is employed to denoise each NASDAQ sector return series. Second, the correlation matrix of sectors is built and analyzed in each time period to view comovements of sectors. Third, hierarchical clustering trees are constructed in each time period to find out how the structure of the NASDAQ market evolves through time. Our results suggest that interrelationships between sectors become stronger in times of crisis and especially in post-crisis period. In addition, some markets tend to form the same cluster in all time periods; for instance the Industrial and Bank sectors and the Telecommunication and Computer sectors. However, the general topology of the NASDAQ market has been considerably changed over periods. In sum, the complex structure of the NASDAQ market is dynamic and is more integrated after 2008 financial crisis. This result indicates that there are less diversification opportunities in the post-crisis period in comparison with pre-crisis period. These empirical findings are important for the development of subsequent portfolio strategies. © 2012 Growing Science Ltd. All rights reserved.

Security Analysis, Dealer‐Analyst Collaboration, and Market Quality: Evidence from the NASDAQ Market in the USA

Abstract: In this study we analyze the effect of the security analysis activities on stock market liquidity and execution quality. We show that stocks followed by financial analysts have better market liquidity and execution quality than stocks with no analyst following, and stocks followed by affiliated analysts have better market liquidity and execution quality than stocks followed by unaffiliated analysts. The superior market liquidity of stocks followed by affiliated analysts can be explained by aggressive dealer quotes from analyst‐dealer information sharing. Overall, our results suggest that public traders benefit from analyst coverage and collaboration between analysts and dealers through high liquidity and low transaction costs.

Order Imbalances Around Seasoned Equity Offerings

Using market microstructure data, we study the determinants of the buying/selling pattern around seasoned equity offerings (SEOs) and their effect on underpricing. We find that the trading pattern around SEOs is slightly positive before the issue date and heavily negative after the SEO, and this pattern is distinctly different from what has been inferred from stock returns. The large negative order imbalances mostly occurred during the late 90s in NASDAQ market, where 86% of underwriters are also market makers and market depth is shallow. The abnormal order imbalances appear to be the result of underwriter market making activities. We also find that SEO underpricing is correlated with the post-issue-date negative order imbalances. The selling pressure on stock returns is estimated as 20% of SEO underpricing, indicating a significant portion of SEO underpricing is related to market making risk.

The effects of listing changes between NASDAQ market segments

This study analyzes the effects of listing changes within NASDAQ market segments during the period of 1998 to 2005. We find that firms phased up from the NASDAQ Small Capital Market (SmallCap) to the NASDAQ National Market (NNM) experienced significant declines in bid-ask spreads, the volatility of returns, and the probability of informed trading, and firms that phased down from NNM to the SmallCap experienced decreases in bid-ask spreads, but insignificant changes in the volatility of returns and the probability of informed trading. We also estimate simultaneous equations models of bid-ask spreads, return volatility, and trading volume for both groups of firms. The results confirm that improved liquidity is associated with the listing changes for the phase-up firms. However, the simultaneous equations model suggests that the decreases in bid-ask spreads for the phase-down firms are caused by the changes in share prices.

Pricing And Long-Run Performance Of The Venture-Backed And Nonventure-Backed IPOS

Initial Public Offerings (IPOs) were the most prevalent form to raise capital by firms wanting to go public during the last decade (1990 2000) in the United State. There were thousands of firms that went public for the first time, mostly in the technology-heavy NASDAQ stock market. Along with the regular IPOs came the IPOs backed by venture capitalists, who specialize in financing promising startup companies and bringing them public. As one-third of the IPOs were backed by venture capitalists during 1990 2000, our purpose here is to examine the pricing and long-run performance of the venture-backed and nonventure-backed IPOs that were issued in the NYSE and NASDAQ stock market during the period covered by our study. We have found, among others, that the venture-backed IPOs performed much better as compared to the nonventure-backed IPOs. The returns of the former were consistently higher than the latter during 1900 2000. Also, the price returns as well as the operating ratios and the growth of cash flows, were higher both in the NYSE and NASDAQ market. The regression equations also confirmed closer association with the independent variables belonging to the IPOs backed by venture capital than the non-venture capital.

Post-Issue Operating Performance Of Nasdaq IPOs

In the ’90s bullish stock markets, it was the IPO which created the bubble of ‘excessive exuberance’, particularly in the technology-heavy NASDAQ market. In our study we have taken a fair sample of NASDAQ IPOs issued during 1990-2000 in order to examine the post-issue operating performance of these IPOs. We have found that during 1990-1995, the mean post-issue one-month return was 1.67%, the mean six-month return was 4.28%, and the mean one-year return was 5.23%, respectively. This could be compared with the results for the 1996-2000 period when the mean one-month return was 3.29%, mean six-month return was 16.96%, and the mean one-year return was 19.97%, respectively. As for the debt/asset and debt/equity ratios for the same two periods, the former was 11.98% and 15.23% for the two periods, and the latter ratio was 5.38% in 1990-1995 and 3.13% in 1996-2000. This clearly shows that the NASDAQ bubble was mainly created by the equity issues, not by the issuance of debt securities. Using the multiple regression equations, we also have found that only the first-day closing price was consistently and negatively associated with annual returns. Obviously, the phenomenon of initial underpricing played a big role in determining the annual return of the NASDAQ IPOs during the last decade in the U.S. securities markets.

The Impact Of Insider Trading On Market Liquidity In The NASDAQ Market

<p class="MsoBlockText" style="margin: 0in 0.6in 0pt 0.5in; mso-pagination: none;"><span style="font-style: normal; font-size: 10pt; mso-bidi-font-style: italic;"><span style="font-family: Times New Roman;">This study examines the relationship between insider trading and market liquidity (spread and depth) of NASDAQ-100 stocks.<span style="mso-spacerun: yes;">  </span>Tests on an intraday sample of sell trades show no evidence of cross-sectional association between the width of the spread and insider trading, but detect some widening of the spread after the fact.<span style="mso-spacerun: yes;">  </span>Overall, our results provide mixed evidence on the ability of NASDAQ dealers to unravel informed order flow and adjust spreads accordingly. <span style="mso-spacerun: yes;"> </span>Their short-term behavior suggests an inability to detect insider trading and widen spreads, but their behavior over time suggests that dealers may attempt to recover what they apparently lose at a given point and time. </span></span></p>

Management Insights

Management Insights

The Behavior of Risk and Market Prices of Risk Over the Nasdaq Bubble Period

We exploit the information in the options market to study the variations of return risk and market prices of different sources of risk during the rise and fall of the Nasdaq market. We specify a model that accommodates fluctuations in both risk levels and market prices of different sources of risk, and we estimate the model using the time-series returns and option prices on the Nasdaq 100 tracking stock. Our analysis reveals three key variations during the period from March 1999 to March 2001. First, return volatility increased together with the rising Nasdaq index level, even though the two tend to move in opposite directions. Second, although the market price of diffusion return risk averages around 1.82 over the whole sample, the estimates reached negative territory at the end of 1999. The estimates reverted back to highly positive values after the collapse of the Nasdaq market. Third, the market price of jump risk increased with the rising Nasdaq valuation, and this increase in market price coincided with an increased imbalance in open interest between put and call options.

Geographic proximity and price discovery: Evidence from NASDAQ

We use the NASDAQ market making context to study the role of geographic proximity in the price discovery of a firm's stock. We show that market makers closer to the firm's headquarters spend more time at the inside bid and ask quotes, initiate larger changes in the quotes, and account for greater information share when compared to non-local market makers. Examining a sample of relocating firms, we also find that market makers moving farther away from the firm after relocation experience a reduction in their contributions to price discovery. Our results suggest that some (local) market makers possess superior information relative to other (non-local) market makers and they trade strategically on this information, a finding that challenges the traditional assumptions in market microstructure theory.

Predictability of nonlinear trading rules in the U.S. stock market

Most of the existing technical trading rules are linear in nature. This paper investigates the predictability of nonlinear time series model based trading strategies in the U.S. stock market. The performance of the nonlinear trading rule is compared with that of the linear model based rules. It is found that the self-exciting threshold autoregressive (SETAR) model based trading rules perform slightly better than the AR rules for the Dow Jones and Standard and Poor 500, while the AR rules perform slightly better in the NASDAQ market. Both the SETAR and the AR rules outperform the VMA rules. The results are confirmed by bootstrap simulations.

Getting Out Early: An Analysis of Market Making Activity at the Recommending Analyst's Firm

ABSTRACTThis paper examines trading volume for Nasdaq market makers around analyst recommendation changes issued by an analyst at the same firm. Using Nasdaq PostData, we find a disproportionate increase in market making volume associated with the firm's recommendation changes and evidence of elevated sell volume at the recommending analyst's firm in the 2 days preceding a downgrade. The implications are that the information source matters in determining the placement of trades and that the issuing analyst's firm appears to be rewarded for prereleasing information through increased volume. These findings constitute new evidence of compensation for research production through the market making channel.

Analysts' Information Based Trading and Market Making: An Analysis on NASDAQ Market Makers

Analysts' Information Based Trading and Market Making: An Analysis on NASDAQ Market Makers

NASDAQ Sector Returns and Market Conditions

This study compares stock returns for NASDAQ sector indices over varying market conditions. The results reveal that, during relatively shorter periods of time, some sectors have generated statistically significantly greater mean monthly returns than those of other sectors. However, for the overall recent ten-year period 1998 through 2007, there were no statistically significant differences between any two NASDAQ sectors. These results therefore indicate that individual long-term investors should not re-allocate funds among sectors based on varying short-term market conditions.