Market Makers under Extreme Market Conditions: Does Timing Matter?

Abstract

This research tests the impact of the nomination of designated market makers in various market conditions. We explore the effect of such announcements on three dimensions: liquidity, volatility, and returns. The findings suggest that, despite the positive contribution that these announcements make to a stock’s liquidity and regardless of the market conditions or the preliquidity levels, they may increase the volatility that accompanies market trends in extreme market conditions. The results have important policy implications because they support the attitude of regulators who tend to postpone the introduction of new mechanisms for enhancing market efficiency during abnormal market conditions and wait for more conventional conditions. Furthermore, contrary to the general view, the results suggest that introducing market makers may not be a stabilizing mechanism. Therefore, regulators should examine alternative stabilizing mechanisms that account for extreme market conditions.