The Making of a Dealer Market: From Entry to Equilibrium in the Trading of Nasdaq Stocks


  • Katrina Ellis,

  • Roni Michaely,

  • Maureen O'Hara

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    • Ellis is from the University of California Davis, Michaely is from Cornell University and IDC, and O'Hara is from Cornell University. The authors thank Dean Furbush, Jenny Drake, and Jodi Burns of the NASD for their help with the data. We also acknowledge the helpful comments of David Easley; Pete Kyle; Tim McCormick; Paul Schultz; George Sofianos; René Stulz (the editor); Ingrid Werner; two anonymous referees; and seminar participants at Duke, LSE, the NYSE Conference on Equity Market Developments, and the 2000 Western Finance Association meetings.


This paper provides an analysis of the nature and evolution of a dealer market for Nasdaq stocks. Despite size differences in sample stocks, there is a surprising consistency to their trading. One dealer tends to dominate trading in a stock. Markets are concentrated and spreads are increasing in the volume and market share of the dominant dealer. Entry and exit are ubiquitous. Exiting dealers are those with very low profits and trading volume. Entering market makers fail to capture a meaningful share of trading or profits. Thus, free entry does little to improve the competitive nature of the market as entering dealers have little impact. We find, however, that for small stocks, the Nasdaq dealer market is being more competitive than the specialist market.