Market microstructure.

• Position: Conference held on December 4, 1998

Members and guests of the NBER's Market Microstructure Project met on December 4 in Cambridge. Their agenda, organized by Bruce Lehmann of University of California, San Diego, and Andrew W. Lo of NBER and MIT, was to discuss these papers:

Matthew Rhodes-Kropf, Columbia University, "Price Improvement in Dealership Markets"

Discussant: Eugene Kandel, Hebrew University

Michael J. Barclay, NBER and University of Rochester; William Christie, Vanderbilt University; Jeffrey Harris, Ohio State University; Eugene Kandel; and Patti Schultz, University of Chicago, "The Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks"

Discussant: Allan Kieldon, Cornerstone Research

Jennifer Lynch Koski, University of Washington, and Roni Michaely, Cornell University, "Prices, Liquidity, and the Information Content of Trades"

Discussant: Robert McDonald, Northwestern University

Peter Christoffersen, McGill University, and Francis X. Diebold, NBER and University of Pennsylvania, "How Relevant Is Volatility Forecasting for Financial Risk Management?"

Discussant: Robert F. Engle, NBER and University of California, San Diego

Reena Aggarwal, U.S. Securities and Exchange Commission, and James J. Angel, Georgetown University, "Optimal Listing Policy: Why Microsoft and Intel Do Not List on the NYSE"

Discussant: Robert Battalio, University of Notre Dame

Rhodes-Kropf examines the strategic behavior of market makers facing price improvements, adverse selection, and changing market conditions. He finds that negotiation, which is forced on dealers by customers with market power, widens spreads but leaves dealers unaffected; this implies that wide quotes are not sufficient to infer excess profits or collusion. Even when price improvements function as a type of price discrimination and dealers choose improvements (without collusion), profits may not increase. Eliminating price improvements allays negotiation costs, improves the equality of execution, and enhances the market transparency.

On January 20, 1997, the Securities and Exchange Commission began implementing a series of reforms that permit the public to compete directly with Nasdaq dealers by submitting binding limit orders. In addition, superior quotes placed by Nasdaq dealers in private trading venues began to be displayed in the Nasdaq market. Barclay, Christie, Harris, Kandel, and Schultz measure the impact of these new rules on various measures of performance, including trading costs and depths...