FIN-01-014

Do Correlated Exposures Influence Intermediary Decision-making? Evidence from Trading Behavior of Equity Dealers

October 12, 2001

Narayan Y. Naik and Pradeep K. Yadav

ABSTRACT

This paper investigates whether dealers’ trading and pricing decisions are governed by their equivalent inventories (based on total returns as in Ho and Stoll, 1983 or on unhedgeable returns as in Froot and Stein, 1998) or by their ordinary inventories, as would be the case in a decentralized market-making organisational structure. It finds that ordinary inventories, and not equivalent inventories best explain dealers’ quote placement strategy, which dealer executes trades and the quality of execution offered to the trades. This finding is consistent with decentralized market making where, due to information sharing difficulties or the nature of compensation contracts, individual dealers care only about risk of stocks managed by them, and not the positions of other dealers within the firm.

Classification: G12, G20, G24

Narayan Y. Naik
Institution: London Business School, UK
Telephone: +44 207 2625050
Fax: 212-995-4233
Email: nnaik@london.edu
Home Page: http://www.london.edu/faculty_research/

Pradeep K. Yadav
Institution: Leonard N. Stern School of Business, New York University
Telephone: 212-998-0305
Fax: 212-995-4233
Email: pyadav@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~pyadav

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