Limit tirders and the alleged Nasdaq collusion

DilTerent methods are used by thm NYSE,‘Amex and the Nasdaq to accommodate limit orders received from investors. This accounts for at least part of the excess of Nasdaq spreads over NYSE spreads, adjusted for trading volume, and is a factor in determining this excess tha: is independent of coitusion on the Nasdaq. The spread-comparison evidence given by others to support their belief that there is collusion among market makers on the Nasdaq therefore overstates the probability of collusion and its significance if it exists. Keywo& Stocks; Spreads; Financial; Nasday; Collusion JEL classijicotion: (314; Gl 8; D23 The evidence supporting the belief that market makers on the Nasdaq have colluded to set spreads is based largely on a comparison of the spreads and their distribution on the NYSE and the Nasdaq (Goldstein, 1993; Christie and Huang, 1994; Christie and Schultz, 1994, Barclay, 1995). These studies show that (1) stocks on the Nasdaq trade at larger spreads than similarly active stocks on the NYSE, (2) spreads become smaller when stocks migrate from the Nasdaq to the NYSE, (3) one-eighth spreads and odd-eighth spreads are few on the Nasdaq as compared to the NYSE, and (4) the distribution of spreads is bimodal on the Nasdaq but unimodal on the h ti SE, unimodal. The present paper argues that in important respects this evidence exaggerates the probability of collusion on the Nasdaq and, if there is collusion, that it overestimates the degree to which this aflects spreads. The basis of my argument is found in the different ways the two exchanges handle limit orders. On the NYSE, the best prices available are made available to the general public for trading purposes, whether these come from Emit orders or the specialist. Limit orders coming to tht NYSE from investors are the major 03OUO5X~7/$17.00