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This article analyses the role of floor brokers in the supply of liquidity on the Australian Stock Exchange Derivatives market. Floor brokers have valuable order execution skills because of their information advantage over off-floor traders and their ability to mitigate some problems related to the option-like characteristics of limit orders. Our results indicate that floor broker participation in the execution of limit orders tends to be high when the above qualities are most valuable. (C) 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 205-218, 2000.
INTRODUCTION
On securities markets with a trading floor, public traders can generally compete with market makers in the supply of liquidity by submitting limit orders. Floor brokers play an important role in this process. For example, Sofianos and Werner (1997) report that on the New York Stock Exchange (NYSE), liquidity provided by floor brokers is 34 percent of the total value of all executed orders. Floor brokers sometimes play a more passive role and simply submit their clients' limit orders to the limit order book, leaving it to the specialist or order book official to execute the order. This article provides an empirical analysis of the floor broker's decision to be actively involved in limit order execution or to use the limit order book. A better understanding of the role of floor brokers in the supply of liquidity is of interest since important markets such as the NYSE, the Chicago Board of Exchange (CBOE) and the Chicago Mercantile Exchange (CME) have decided to maintain an active trading floor, whereas several other markets have moved to a floorless trading system (e.g., Deutsche Termin Borse, the Osaka Securities Exchange, the Paris Bourse, and the Tokyo Stock Exchange).
Harris (1990) argues that limit order traders face two problems that can be partially solved by floor brokers. The first problem is what he refers to as quote matching. To illustrate, assume that a large order to buy a stock is entered into the limit order book. In reaction to this order, a quote matcher might offer to buy at a slightly higher price. If the quote matcher's quote is hit and the price subsequently rises, the quote matcher makes a profit. If the quote is hit and the stock price falls,...