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Order preferencing, adverse-selection costs, and the probability of information-based trading

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Abstract

Although prior studies offer various conjectures on the causes and consequences of order preferencing, there is only limited empirical evidence. In this study, we show that the extent of order preferencing is significantly and negatively related to both the adverse-selection component of the spread and the probability of information-based trading. This result is consistent with the prediction of the clientele-pricing hypothesis that dealers (brokers) selectively purchase (internalize) orders based on information content. Our results suggest that order preferencing may not be as harmful as some researchers have suggested and offer some rationale for its prevalence in securities markets with heterogeneously informed traders.

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Author information

Authors and Affiliations

  1. Department of Finance and Managerial Economics, State University of New York (SUNY) at Buffalo, Buffalo, NY, 14260, USA

    Kee H. Chung

  2. Department of Accounting and Finance, Indiana University-Purdue University at Fort Wayne, Fort Wayne, IN, 46805, USA

    Chairat Chuwonganant

  3. The Securities and Exchange Commission, 100 F Street, NE Washington, DC, 20549

    D. Timothy McCormick

Authors
  1. Kee H. Chung
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  2. Chairat Chuwonganant
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  3. D. Timothy McCormick
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Corresponding author

Correspondence to Kee H. Chung.

Additional information

JEL Classification G18 · G19

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Chung, K.H., Chuwonganant, C. & McCormick, D.T. Order preferencing, adverse-selection costs, and the probability of information-based trading. Rev Quant Finan Acc 27, 343–364 (2006). https://doi.org/10.1007/s11156-006-0042-3

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  • DOI: https://doi.org/10.1007/s11156-006-0042-3

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