How Brokers Facilitate Trade for Long-Term Clients in Competitive Securities Markets

In adverse-selection models of security market microstructure, a market maker could enhance efficiency if he or she were willing to sustain short-term trading losses. We show that this desirable activity can be supported as a self-enforcing agreement between broker-dealers and long-lived clients. An...

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Bibliographic Details
Published in:The Journal of business (Chicago, Ill.) Ill.), 1995-01, Vol.68 (1), p.1-33
Main Authors: Aitken, Michael J., Garvey, Gerald T., Swan, Peter L.
Format: Article
Language:English
Subjects:
Australia
Brokerages
Business orders
Business strategies
Coefficients
Competitiveness
Fees
Linear regression
Liquidity
Market prices
Price premiums
Securities issues
Securities markets
Stock brokers
Stock exchange
Stocks
Trade
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Summary:In adverse-selection models of security market microstructure, a market maker could enhance efficiency if he or she were willing to sustain short-term trading losses. We show that this desirable activity can be supported as a self-enforcing agreement between broker-dealers and long-lived clients. An implication is that brokers who sustain such losses should charge higher fees to long-term clients for trades where the broker merely receives a commission. This prediction is supported by an analysis of brokerage rates on the Australian Stock Exchange. By contrast, market makers who make trading profits charge lower agency fees to large, long-term clients.
ISSN:0021-9398
1537-5374
DOI:10.1086/296651