NASDAQ MARKET-STRUCTURE AND SPREAD PATTERNS

Because of its institutional features, the Nasdaq market does not fit the standard competitive model. We construct a model that reflects the distinguishing characteristics of the Nasdaq market. This model impli es that in dealer markets with a minimum price increment, competition among market-makers does not necessarily drive spreads down to the lev el of marginal cost. Using this result, we provide an explanation for the odd-eighth avoidance documented in Christie and Schultz (1994). We show that market-makers can use odd-tick avoidance as a coordination device to increase spreads. Evidence from Nasdaq supports our hypothes es.