FIN-02-029

The "Make or Take" Decision in an Electronic Market: Evidence on the Evolution of Liquidity

August 2002

Robert Bloomfield, Maureen O´Hara, and Gideon Saar

ABSTRACT
This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders, and how these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. We also find that liquidity provision shifts over time, with informed traders increasingly providing liquidity in markets. This evolution is consistent with the risk advantage informed traders have in placing limit orders. Thus, a market making role emerges endogenously in our electronic markets.

Robert Bloomfield
Institution: Johnson Graduate School of Management, Cornell University
Email: rjb9@cornell.edu

Maureen O´Hara
Institution: Johnson Graduate School of Management, Cornell University
Email: mo19@cornell.edu

Gideon Saar
Institution: Leonard N. Stern School of Business, New York University
Telephone: 212-998-0318
Fax: 212-995-4233
Email: gsaar@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~gsaar

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