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RFS Advance Access originally published online on August 18, 2004
Review of Financial Studies 2005 18(4):1343-1368; doi:10.1093/rfs/hhi002
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The Review of Financial Studies Vol. 18, No. 4 © 2004 The Society for Financial Studies; all rights reserved. For Permissions, please email: journals.permissions@oupjournals.org

Why Do Larger Orders Receive Discounts on the London Stock Exchange?

Dan Bernhardt
University of Illinois

Vladimir Dvoracek
University College of the Fraser Valley

Eric Hughson
University of Colorado

Ingrid M. Werner
The Ohio State University

Address correspondence to: Eric Hughson, Leeds School of Business, University of Colorado, Boulder, CO 80309, or e-mail: Eric.Hughson{at}colorado.edu.

We argue that competition between dealers in a classic dealer market is intertemporal: A trader identifies a particular dealer and negotiates a final price with only the intertemporal threat to switch dealers imposing pricing discipline on the dealer. In this kind of market structure, we show that dealers will offer greater price improvement to more regular customers, and, in turn, these customers optimally choose to submit larger orders. Hence, price improvement and trade size should be negatively correlated in a dealer market. We confirm our model’s predictions using unique data from the London Stock Exchange during 1991.


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