We examine block trades on the Paris Bourse to test several theoretical predictions regarding upstairs trading, and exploit cross-sectional variation in “crossing rules” on the Paris Bourse to provide evidence on their relevance. Paris provides an excellent setting to test the implications of upstairs intermediation models, because its electronic limit order market closely resembles the downstairs markets envisioned by theorists. We present direct evidence in support of Grossman’s (1992) prediction that upstairs brokers lower execution costs by tapping into pools of unexpressed liquidity, as actual execution costs upstairs are less than one third as large as would be anticipated if block trades were executed against displayed liquidity in the downstairs market. Consistent with prior analyses, the Paris data also supports the Seppi (1990) hypothesis…
that upstairs brokers certify trades as uninformed. We find that participants in stocks with less restrictive crossing rules agree to outside-the-quote executions for more difficult trades and at times when downstairs liquidity is lacking. These likely represent trades that could not have been otherwise completed, suggesting that market quality can be enhanced by allowing participants more flexibility to execute blocks at prices outside the quotes, a consideration particularly relevant to U.S. markets in the wake of decimalization.
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