DO INVENTORIES MATTER IN DEALERSHIP MARKETS - EVIDENCE FROM THE LONDON STOCK-EXCHANGE

Using London Stock Exchange data, we test the central implication of t he canonical model of Ho and Stoll (1983) that relative inventory diff erences determine dealer behavior. We find that relative inventories e xplain which dealers obtain large trades and show that movements betwe en best ask, best bid, and straddle are highly correlated with both st andardized and relative inventory changes. We show that the mean rever sion in inventories is highly nonlinear and increasing in inventory le vels. We show that a key determinant of variations in interdealer trad ing is inventories and that interdealer trading plays an important rol e in managing large inventory positions.