Chapter 37 MARKET MAKERS. Abstract The primary focus of this entry is on market maker services, revenues, and costs. A market maker’s basic function is to service the public’s demand to trade with immediacy by continuously standing ready to buy shares from customers who wish to sell, and to sell shares to customers who wish to buy. | Chapter 37 MARKET MAKERS1 ROBERT A. SCHWARTZ City University of New York USA LIN PENG City University of New York USA Abstract The primary focus of this entry is on market maker services revenues and costs. A market maker s basic function is to service the public s demand to trade with immediacy by continuously standing ready to buy shares from customers who wish to sell and to sell shares to customers who wish to buy. Additionally the market maker helps to stabilize prices and to facilitate a reasonably accurate price discovery. Further a special type of market maker - a stock exchange specialist - fulfills the role of an auctioneer. The bid-ask spread is the classic source of market maker profits while the costs of market maker operations include orderprocessing risk-bearing the cost of carrying an unbalanced portfolio and adverse selection the cost of trading with a better-informed participant . The paper further considers the competitive environment that market makers operate within and concludes with the thought that institutionalization the advent of electronic trading deregulation and globalization of the equity markets have led to major changes in market maker operations in the recent past and will continue to do so in the coming years. Keywords adverse selection bid-ask spread competitive environment electronic trading exchange specialist immediacy market maker order-processing price stabilization price discovery risk-bearing Market makers play a central role in many equity markets by buying and selling shares to service the public s demand to trade immediately the classic service provided by a dealer . Market makers are also responsible for stabilizing prices making a market fair and orderly and facilitating price determination. Some market makers such as stock exchange specialists also perform the role of auctioneer. Demsetz 1968 was one of the first to analyze the supply of immediacy. Buyers and sellers arrive sporadically at the market and it is not a
