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Quoting Activity and the Cost of Capital

Published online by Cambridge University Press:  07 September 2020

Ioanid Rosu Open the ORCID record for Ioanid Rosu [Opens in a new window] ,
Elvira Sojli Open the ORCID record for Elvira Sojli [Opens in a new window]  and
Wing Wah Tham Open the ORCID record for Wing Wah Tham [Opens in a new window]
Ioanid Rosu*
Affiliation:
HECParis
Elvira Sojli
Affiliation:
University of New South [email protected]
Wing Wah Tham
Affiliation:
University of New South [email protected]
*
[email protected] (corresponding author)
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Abstract

We study the quoting activity of market makers in relation to trading, liquidity, and expected returns. Empirically, we find larger quote-to-trade (QT) ratios in small, illiquid, or neglected firms, yet large QT ratios are associated with low expected returns. The last result is driven by quotes, not by trades. We propose a model of quoting activity consistent with these facts. In equilibrium, market makers monitor the market faster (and thus increase the QT ratio) in neglected, difficult-to-understand stocks. They also monitor faster when their clients are more precisely informed, which reduces mispricing and lowers expected returns.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 8 , December 2021 , pp. 2764 - 2799
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We thank two anonymous referees, Hendrik Bessembinder (the editor), Dion Bongaerts, Jean-Edouard Colliard, David Easley, Thierry Foucault, Michael Goldstein, Amit Goyal, Johan Hombert, Dashan Huang, Maureen O’Hara, Rohit Rahi, Daniel Schmidt, and Yajun Wang for their suggestions. We are also grateful to finance seminar participants at the Stockholm Business School, the Academy of Economic Studies in Bucharest, Cass Business School, the University of British Columbia, Pontifical University of Chile, the University of Chile, the University of Technology Sydney, and HEC Paris, as well as conference participants at the 2018 Australasian Finance and Banking Conference, 2018 Financial Management Association Meeting, 2018 Behavioural Finance and Capital Markets Conference, 2018 European Finance Association Meeting, 2018 Monash Workshop on Financial Markets, 2017 French Finance Association (AFFI)/European Financial Data Institute (EUROFIDAI) Meeting, 2017 Hong Kong Conference on Market Design and Regulation in the Presence of High-Frequency Trading, 2017 Financial Integrity Research Network (FIRN) Meeting, 2017 Northern Finance Association Meeting, 2017 Sustainable Architecture for Finance in Europe (SAFE) Market Microstructure Conference, 2017 Erasmus Liquidity Conference, 2017 Risk Management Institute (RMI) Risk Management Conference, 2017 Center for Economic and Policy Research (CEPR)-Imperial-Plato Inaugural Conference, 2017 Frontiers of Finance Conference, 2017 FIRN Sydney Market Microstructure Conference, and 2016 CEPR Gerzensee European Summer Symposium in Financial Markets for valuable comments.

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