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Price Improvements in Financial Markets as a Screening Device

Abstract : In many security markets, market-makers offer to trade at a discount relative to their posted bid and ask quotes. In this article we provide an explanation to this phenomenon. We show that market-makers can mitigate informational asymmetries by selectively offering price improvements to their regular clients. We study a specific type of pricing strategy which consists (a) in offering price improvements to investors who have not repeatedly inflicted trading losses to the market-maker uses this pricing strategy, there are equilibria in which his clients optimally choose not to contact him when they have private information. These equilibria Pareto-dominate those which are obtained when the market-marker does not or can not make his quotes contingent on his clients' trading histories. Our Model predicts that (1) market-makers should grant price improvements to their regular clients but that (2) these improvements should be temporarily suspended after sequences of purchases (sales) followed by price increases (decreases).
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https://hal-hec.archives-ouvertes.fr/hal-00598169
Contributor : Antoine Haldemann <>
Submitted on : Saturday, June 4, 2011 - 10:10:02 PM
Last modification on : Thursday, March 5, 2020 - 4:26:32 PM

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  • HAL Id : hal-00598169, version 1

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Thierry Foucault, Gabriel Desgranges. Price Improvements in Financial Markets as a Screening Device. 2011. ⟨hal-00598169⟩

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