Designated Market Makers: Competition and Incentives

Abstract

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in the realized spread. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our results are of relevance for designing optimal contracts between exchanges and DMMs, as well as for regulatory market oversight.