On the Optimal Allocation of Security Listings to Specialists

March 2013.

This paper addresses the question of how securities with correlated payoffs should be allocated to dealers in a specialist system. Using a multi-asset model of an imperfectly competitive market, we examine the effect of alternative security allocations on the specialists' market power and on their adverse selection risk. We demonstrate that specialists are always better off when their portfolios contain securities with highly correlated payoffs, and provide conditions under which risk-averse investors prefer such an allocation as well. Intuitively, this is the case when the investors' order flow is sufficiently informative about the value of the traded securities. We also discuss how the allocation of security listings to specialists affects market liquidity.

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