Do dealer firms manage inventory on a stock-by-stock or a portfolio basis?

Finance, Finance

IFA Working Paper

Naik N Y; Yadav P

Narayan Naik

2001

This paper investigates whether dealers' trading and pricing decisions are governed by their equivalent inventories (based on total returns as in Ho and Stoll, 1983 or on unhedgeable returns as in Froot and Stein, 1998) or by their ordinary inventories, as would be the case in a decentralized market-making organisational structure. It finds that ordinary inventories, and not equivalent inventories best explain dealers' quote placement strategy, which dealer executes trades and the quality of execution offered to the trades. This finding is consistent with decentralized market making where, due to information sharing difficulties or the nature of compensation contracts, individual dealers care only about risk of stocks managed by them, and not the positions of other dealers within the firm.

Institute of Finance and Accounting, Institute of Finance and Accounting

FIN 337

IFA Working Paper

No