We report the results of an experiment designed to investigate the behavior of quoted spreads in multiple-dealer markets. We manipulate verbal communication (not allowed and allowed) and order preferencing (not allowed, allowed, and allowed with order-flow payment) between eighteen sessions. Without preferencing, spreads are wider when communication is allowed. With preferencing (and no order-flow payments), individuals do not have incentives to narrow the spread and a wide spread may be maintained without a collusive agreement. However, spreads narrow somewhat when individuals are given the opportunity to compete using alternatives to price (that is, payment for order flow).
JEL classification: G10, G18
Key words: bid-ask spread, preferencing, collusion
The authors thank Karen Butler and Jitanjli Datt for research assistance and George Benston, Paul Bolster, Paul Seguin, workshop participants at the Federal Reserve Bank of Atlanta, and two anonymous referees for helpful comments. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
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