Market Liquidity and Competition Among Designated Market Makers

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? We employ data from NYSE Euronext Paris to show that exogenous changes in contract design lead to significant decreases in quoted and effective spreads. In particular, market liquidity increases the most for stocks with the largest increase in competition among DMMs. Our analysis shows that competition among DMMs is an important aspect of contract design, along with elements such as rebates and requirements. This paper was accepted by Kay Giesecke, finance. Funding: M. G. Subrahmanyam thanks the Alexander von Humboldt Foundation for generous financial support via the Anneliese Maier Award. L. Pelizzon thanks the Leibniz Institute for Financial Research SAFE for financially sponsoring this research and Italian Ministry for University and Research [MIUR–2017RSMPZZ]. This work was also supported by the Deutsche Forschungsgemeinschaft [Grant 329107530]. Supplemental Material: The Internet Appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01801 .