MARKET MAKING, THE TICK SIZE, AND PAYMENT-FOR-ORDER FLOW - THEORY AND EVIDENCE

We analyze the effects of a finite tick size and the practice of ''payment-for-order flow'' on market maker competition. Even if the New York Stock Exchange (NYSE) reservation price is superior to its non-NYSE counterpart, brokers may, because of payment-for-order flow, prefer to execute orders off the NYSE floor, In accordance with the implications of the model, empirical analysis suggests that non-NYSE market makers trade a larger fraction of the smaller order sizes and offer fewer price improvement opportunities and that large companies appear to have enhanced price improvement opportunities on the NYSE.