A Specialist's Quoted Depth as a Strategic Choice Variable
12-96
Posted: 18 Sep 1996
Date Written: July 1996
Abstract
There are two distinct components to a specialist's price schedule, prices and depths. This paper presents a model of a specialist's problem of choosing prices and depths jointly in order to maximize profits. Closed form solutions are provided for both constrained and unconstrained versions of the model. The contribution of this work is twofold. First, the model demonstrates the strategic importance of depths for the specialist and highlights its effect on overall liquidity. Second, the joint responses of prices and depths to various concerns of the specialist may be useful in differentiating between competing microstructure effects. Comparative static results show how depths respond to changes in: (1) the amount of asymmetric information, (2) uncertainty about the terminal value, (3) the prior probability assessments of future prices and (4) the distribution of liquidity trades.
JEL Classification: G10, G14
Suggested Citation: Suggested Citation