Do We Need Electronic Stock Dealers?

Stock dealers are investment firms that trade out of their own inventories by internalizing the trades off exchanges. We analyze the extent to which traders' stock transactions occur with dealers and the associated costs. Traders face a choice between exchanges' anonymous trading and high transparency and dealers' negotiation ability and low transparency. The choice hinges on the trade-off between avoiding price impact and paying low costs for liquidity supply. Our results show that dealer trades have lower price impact, and cost more, than exchange trades. Hence, traders might choose dealers over exchanges to avoid price impact, and they might be willing to pay the associated higher liquidity supply cost. In our analyses, we look to Systematic Internalizers (SIs), who are dealers with slack regulation relative exchanges when it comes to transparency and minimum tick size. We show that dealers' comparative advantages matter for attracting trade flow