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Why do NASDAQ Market Makers Avoid Odd-Eighth Quotes?

WILLIAM G. CHRISTIE Vanderbilt University - Finance PAUL H. SCHULTZ University of Notre Dame - Department of Finance & Business Economics

Abstract:

    The NASDAQ multiple dealer market is designed to produce narrow bid-ask spreads through competition for order flow among individual dealers. However, we find that odd-eighth quotes are virtually non-existent for 71 of 100 actively traded NASDAQ securities, including Apple Computer and Lotus Development. The lack of odd-eighth quotes cannot be explained by the negotiation hypothesis of Harris (1991), trading activity, or other variables thought to impact spreads. This result implies that the inside spread for a large number of NASDAQ stocks is at least $.25, and raises the question of whether NASDAQ dealers implicitly collude to maintain wide spreads.
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