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Payments for Order Flow on Nasdaq


  • Eugene Kandel,

    1. Hebrew University
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  • Leslie M. Marx

    1. University of Rochester
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    • Kandel is at Hebrew University; Marx is at the University of Rochester. We thank an anonymous referee, Mike Barclay, Rob Battalio, Hank Bessembinder, Bhagwan Chowdry, Bill Christie, Darrell Duffie, Jason Greene, Larry Harris, Charles Lee, Ananth Madhavan, Maureen O'Hara, Paul Pfleiderer, Paul Schultz, René Stulz (the editor), Avanidhar Subrahmanyam, and the participants of workshops at Arizona State, Berkeley, Cornell, Hebrew, Laval, Stanford, University of California Los Angeles, and the University of Southern California for helpful discussions. This paper was presented at the Charles Dice Conference on Dealer Markets at Ohio State. Kandel thanks the Harvey Krueger Center for financial support.


We present a model of Nasdaq that includes the two ways in which marketmakers compete for order flow: quotes and direct payments. Brokers in our model can execute small trades through a computerized system, preferencing arrangements with marketmakers, or vertical integration into market making. The comparative statics in our model differ from those of the traditional model of dealer markets, which does not capture important institutional features of Nasdaq. We also show that the empirical evidence is inconsistent with the traditional model, which suggests that preferencing and vertical integration are important components in understanding Nasdaq.