A Specialist's Quoted Depth and the Limit Order Book


  • Kenneth A. Kavajecz

    1. Wharton School, University of Pennsylvania
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    • * Wharton School, University of Pennsylvania. I gratefully acknowledge the comments of Marshall Blume, Tim Bollerslev, Matthew Clayton, Michael Fishman, Simon Gervais, Lawrence Gorman, Kathleen Hagerty, Lawrence Harris, Bjorn Jorgensen, Joan Kavajecz, Robert McDonald, Craig MacKinlay, Elizabeth Odders-White, Mitchell Petersen, Robert Porter, Patrik Sandås, and of Jim Shapiro and Jennifer Quinn of the NYSE. In addition, I have benefited greatly from comments by René Stulz and an anonymous referee. All remaining errors are of course my own.


By partitioning quoted depth into the specialist's contribution and the limit order book's contribution, the paper investigates whether specialists manage quoted depth to reduce adverse selection risk. The results show that both specialists and limit order traders reduce depth around information events, thereby reducing their exposure to adverse selection costs. Moreover, specialists' quotes may reflect only the limit order book on the side (or sides) of the market where they believe there is a chance of informed trading. Changes in quoted depth are consistent with specialists managing their inventory as well as having knowledge of the stock's future value.