Venkatesh Panchapagesan

Competition among markets: The repeal of Rule 390

Abstract The New York Stock Exchange repealed its Rule 390 on May 8, 2000. The rule disallowed exchange members from trading stocks listed prior to April 26, 1979 outside of an exchange. We examine the implications of the rule’s repeal on the competition for order flow as well as on measures of market quality such as spreads, depth and price improvement for stocks impacted by the rule. We use a second sample of stocks not subject to Rule 390 (Rule 19c-3 stocks) to control for market wide trends. We have three important findings: (1) Quoted spreads decrease by about 18% for Rule 390 stocks, three times more than the reduction for Rule 19c-3 stocks; (2) Effective spreads do not change; and (3) The NYSE lost little market share, even in smaller trades that were supposed to migrate, following the repeal. Our results indicate a paradigm shift in the way the NYSE specialists make a market. Prior to the repeal, the specialists set wider quotes but provided extensive price improvement. Following the repeal, the specialists set tighter quotes with lesser price improvement possibilities. We believe that this shift is a strategic response by the specialists to retain market share, not by improving market quality but by making order flow internalization and payment for order flow less profitable. As a result, competition improves market quality – but not in the way we would generally expect.

The First Price of the Day

The opening trading session is arguably the most crucial of the entire day, given the powerful combination at the open of concentrated volume and high uncertainty following the overnight or weekend non–trading period. The authors examine the process of price discovery at the New York Stock Exchange single–price opening auction. The analysis sheds light on the role of the specialist and provides insights into how openings on other markets–such as Nasdaq–might be structured. In particular, the presence of designated dealers facilitates price discovery over an automated call auction market, perhaps because specialists obtain valuable information by observing the evolution of the limit order book. In addition, the specialists opening trade reflects non–information factors such as price stabilization requirements. Finally, the authors note that it is not feasible to trade thin stocks in call markets without either the presence of a designated dealer or a high degree of transparency.

Do Indian Business Group Owned Mutual Funds Maximize Value for Their Investors

The manager of an Indian business group (BG) fund can have access to private information on its own BG firms and their industries. However, since the fund belongs to a BG, the fund manager may also have incentives to undertake investments that benefit the BG firm managers and not its fund investors. In this paper, we examine the relation between a business group (BG) mutual fund’s return performance and its ownership levels in (i) its own BG firms, and in (ii) the rivals of its BG firms that operate in the same industries. Using return and portfolio holdings data on a survivorship-bias free sample of Indian BG mutual funds for the period 2002-2010 we find that the relation between a BG fund’s risk-adjusted returns and its ownership in its own BG firms or firms in BG industries is roughly in the form of an inverted “V,” i.e., funds underperform whenever they increase or decrease their investment in group firms or rival firms beyond what a typical fund invests in these firms. The effect is stronger for underinvestment. This finding for BG firms suggests opportunistic behavior on the part of the BG fund manager.