The Effects of Trader Type on Market Maker’s Effective Bid-Ask Spread

Abstract

Using intraday trading data on U.S. Treasury note futures, we analyze the effects of trader type on market maker’s effective bid-ask spread. We find that market makers tend to experience losses when price uncertainty increases in the market, even though market maker’s effective BASs are positive on average. When the overall trading volume increases, the effects of economies of scale and competition between market makers and exchange member institutions cause market makers to narrow the effective bid-ask spread. However, when off-exchange traders increase their trading volume, market makers respond by lowering their buy prices and increasing sell prices, thereby widening the effective bid-ask spread. The results reveal that market makers protect themselves against risk when trading with off-exchange traders.