Journal of Financial Economics 63 (2002) 133–158

Liquidity provision and specialist trading

in NYSE-listed non-U.S. stocks$
Jeffrey M. Bacidore*, George Sofianos
Goldman Sachs & Co., Derivatives and Trading Research, One New York Plaza, 42 Floor, New York,
NY 10004, USA
Received 11 May 2000; accepted 1 December 2000

Abstract

We examine how the intrinsic differences between U.S. and non-U.S. stocks affect market
participants and the market quality of non-U.S. stocks relative to U.S. stocks. Using
proprietary data on NYSE specialist trading, we find that, all else equal, specialist closing
inventory positions for non-U.S. stocks are closer to zero than U.S. stocks. The evidence on
specialist participation and stabilization rates is mixed. Non-U.S. stocks from developed
markets have higher specialist participation and stabilization rates than U.S. stocks, while
emerging market stocks have lower participation and stabilization rates than U.S. stocks.
With respect to market quality, we find that, all else equal, non-U.S. stocks have wider
spreads, less depth, and greater transitory volatility than U.S. stocks. We investigate
the reasons behind the difference in liquidity and find that the larger non-U.S. spreads
are primarily due to higher information asymmetry and increased adverse selection risk.
We conclude that liquidity providers demand greater compensation for trading non-U.S.
stocks, but this additional compensation is necessary to offset the higher adverse selection risk.
r 2002 Elsevier Science S.A. All rights reserved.

$
The authors thank Shane Corwin, Steve Foerster, Bob Jennings, Venkatesh Panchapagesan, an
anonymous referee, seminar participants at the University of Colorado at Boulder, the University of
Georgia, the University of Pittsburgh, and participants of the 1999 European Finance Association and
2000 Western Finance Association meetings for their comments. We also thank Pamela Dottin and Jean
Tobin for their help in securing some of the data used in this project as well as Madhu Kannan and Boris
Raykin for their previous work on this study. Any remaining errors are the responsibility of the authors. A
previous draft of this paper was titled ‘‘NYSE Specialist Trading in Non-U.S. stocks.’’ This work was
completed while Bacidore and Sofianos were Director, Research, and Vice President, Research,
respectively, at the NYSE. The comments and opinions expressed in this paper are the authors’ and do
not necessarily reflect those of the directors or officers of Goldman, Sachs & Co. or the directors,
members, or officers of the New York Stock Exchange, Inc.
*Corresponding author. Tel.: +1-212-357-0636; fax: +1-212-428-9023.
E-mail address: jeff.bacidore@gs.com (J.M. Bacidore).

0304-405X/02/$ - see front matter r 2002 Elsevier Science S.A. All rights reserved.
PII: S 0 3 0 4 - 4 0 5 X ( 0 1 ) 0 0 0 9 2 - 7
134 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

JEL classification: G14; G15

Keywords: NYSE specialist; ADRs; Adverse selection; Information asymmetry

1. Introduction

Over the last decade, the cross-border listing and trading of stocks has accelerated.
The number of non-U.S. companies listed on the New York Stock Exchange
(NYSE), for example, has grown 400%, from 77 companies in 1988 to 392 by the
end of 1998.1 Over the same period domestic listings increased 70%.2 The dramatic
increase in non-U.S. listings on the NYSE raises interesting questions regarding how
these stocks are traded in the U.S. The purpose of this study is to examine how
differences between non-U.S. and U.S. stocks affect liquidity provision.
Domowitz et al. (1998) show that the market quality of cross-listed stocks depends
on the degree to which markets are linked informationally. For markets that are
sufficiently segmented, trading costs are higher for cross-listed stocks due to greater
adverse selection associated with arbitrageurs who exploit pricing differences across
these segmented markets at the expense of less-informed liquidity providers.
Furthermore, if capital is not permitted to flow freely across markets, liquidity
providers incur greater inventory carrying costs as their access to foreign order flow
is restricted. Alternatively, if markets are sufficiently linked, trading costs and
volatility may be reduced due to greater competition across markets, increased
trading activity, and decreased adverse selection. Similarly, Chowdry and Nanda
(1991) show that when markets are not perfectly linked, informed traders can
increase their profits by trading in multiple markets. Consequently, the more tightly
linked the markets are, the easier it is to detect informed trading, which, in turn,
should lead to an increase in liquidity.
Trading in non-U.S. stocks, therefore, could be more or less liquid than trading in
U.S. stocks, ceteris paribus, and should depend on the degree to which markets are
linked. For example, Canadian stocks trade as ordinary securities as opposed to
American Depositary Receipts (ADRs), the trading hours in Canada overlap with
those of the U.S., and competition across the two markets is vigorous. As a result,
one might expect Canadian stocks listed on the NYSE to trade more like U.S. stocks.
On the other hand, the differences may be most severe for emerging market stocks
since their home market is often less transparent and less tightly linked
informationally with U.S. markets. As a result, trading costs, volatility, and adverse
selection should be greatest for non-U.S. stocks from emerging markets and less so
for developed market stocks.
1
The official NYSE figures for non-U.S. companies at the end of 1998 is 379. The official figure only
includes non-U.S. companies that list their common stock on the NYSE; 13 non-U.S. companies only list
preferred stock.
2
These numbers are based upon the total number of companies listing common or preferred stock. The
difference in growth rates between U.S. and non-U.S. listings is approximately the same based on common
stock alone.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 135

To test these predictions, we begin by examining whether liquidity providers on

the NYSE alter their behavior in response to the special risks associated with non-
U.S. stocks: do they hold less inventory, trade less often, stabilize prices less
frequently? We do this by investigating the trading behavior of NYSE specialists,
one special group of liquidity providers in NYSE-listed securities. While liquidity is
also supplied by floor brokers and off-floor traders who submit electronic orders
through the NYSE systems, focusing on specialist trading behavior is particularly
interesting given specialists’ unique access to order flow and their affirmative and
negative obligations (including acting as ‘‘liquidity provider of last resort’’). Indeed,
Cao, Choe, and Hatheway (1997) and Corwin (1999) find that trading costs differ
across specialist firms, suggesting that specialists influence trading costs. To the
extent that specialists have a direct influence over trading costs, it is interesting to see
whether differences between U.S. and non-U.S. stocks lead to differences in
specialist trading behavior since such differences may have an influence on trading
costs.
Using proprietary data on NYSE specialist trading for July 1998, we compare
specialist closing inventories, intraday participation and stabilization rates for non-
U.S. stocks and a matched sample of U.S. stocks.3 We find that mean specialist
closing inventory positions for non-U.S. stocks are about 60% smaller in absolute
value than for comparable U.S. stocks. With respect to the intraday trading of
specialists, we find mixed results. Overall, specialist participation and stabilization
rates for non-U.S. stocks are not statistically significantly different than those of
U.S. stocks. However, when we partition the sample into developed and emerging
market non-U.S. stocks, an interesting pattern emerges. We find some evidence that
participation and stabilization rates of developed market non-U.S. stocks are higher
than those of U.S. stocks. Participation and stabilization rates of emerging market
non-U.S. stocks, on the other hand, are significantly smaller than those of U.S.
stocks.
When the data are partitioned by region, we find essentially no difference between
U.S. stocks and non-U.S. stocks from the Asia-Pacific region and Canada. Stocks
from Europe have significantly larger participation and stabilization rates, while
those from Latin America have significantly lower participation rates. Given the
strong linkages between Canada and the U.S. and the relatively low level of linkages
for emerging market stocks, the finding for Canadian stocks and Latin American
stocks are not surprising. However, the fact that the Asia-Pacific stocks have similar
participation and stabilization rates despite the fact that trading hours do not
overlap is interesting, as is the finding that European stocks have significantly higher
participation and stabilization rates than U.S. stocks.
With respect to market quality, we find that both developed and emerging market
non-U.S. stocks have larger quoted and effective spreads, less quoted depth, and
greater volatility than matched U.S. stocks. On average, non-U.S. stocks have
quoted (effective) spreads of 1.17 (0.77)%, relative to 0.69 (0.45)% for a matched

3
Hasbrouck and Sofianos (1993) and Madhavan and Sofianos (1998) provide research on participation
rates and inventory levels of specialists as well as the factors influencing these measures.
136 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

U.S. sample. Non-U.S. stocks have one-third less quoted depth and are almost twice
as volatile as a matched U.S. sample. We also find that non-U.S. stocks have larger
realized spreads and larger adverse selection components than the matched U.S.
stocks, regardless of whether the stock is from a developed or emerging market.
However, when we control for residual differences in price, volatility, and size
between the non-U.S. and the matched U.S. samples, the differences in realized
spreads are no longer significant. This finding suggests that the difference in market
quality between U.S. and non-U.S. stocks is driven primarily by differences in
information asymmetry and adverse selection.
It is important to bear in mind that we are comparing market quality between U.S.
and non-U.S. stocks on the NYSE and not market quality between the NYSE and
the home market in NYSE-listed non-U.S. stocks.4 Even though we find, for
example, that on the NYSE spreads on non-U.S. stocks are wider than on U.S.
stocks, the NYSE spreads on non-U.S. stocks may still be narrower than their
spreads in the home market.
The remainder of this paper is organized as follows. In Section 2, we discuss
differences between U.S. and non-U.S. stocks, and in Section 3 we discuss the
theoretical and empirical implications of these differences. Section 4 describes our
data and methodology. Section 5 presents the results of our empirical analysis of
specialist trading and market quality. Section 6 concludes the paper with a discussion
of the policy implications of our findings.

2. Differences between U.S. and non-U.S. stocks

NYSE-listed U.S. and non-U.S. stocks trade under the same market structure. For
both U.S. and non-U.S. stocks, for example, trading on the NYSE takes place
between 9:30 a.m. and 4:00 p.m. (ET), prices are quoted in U.S. dollars, and the
minimum trading variation is the same. Like U.S. stocks, non-U.S. stocks pay
dividends in dollars and clear and settle through U.S. clearance and settlement
institutions.
Major differences, however, exist across the two groups of stocks, with respect to
both the structure and fungibility of the securities themselves as well as to the flow of
information related to these securities. One important difference between U.S. and
non-U.S. stocks is that most non-U.S. stocks have an active home market. For U.S.
stocks, most trading takes place in the U.S., with the vast majority of trading and
price discovery occurring on the NYSE (see, e.g., Blume and Goldstein, 1997;
Hasbrouck, 1995).5 Furthermore, the linkages across the U.S. markets are stronger
than those linking U.S. markets to non-U.S. markets.6 For example, the U.S. stock
4
Several papers compare market quality between the U.S. and the home market. See for example,
Domowitz et al. (1998) on Mexican stocks, Foerster and Karolyi (1998) on Canadian stocks, Werner and
Kleidon (1996) on U.K. stocks, Venkataraman (1999) and Piwowar (1997) on French stocks. Pulatkonak
and Sofianos (1999) examine the distribution of trading volume between the U.S. and the home market.
5
In 1998, o2% of global trading volume in NYSE-listed U.S. stocks was executed outside the U.S.
6
See Hasbrouck et al. (1993), for a discussion of these linkages.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 137

markets are connected via the Consolidated Quote System, the Consolidated Tape
System, and the Intermarket Trading System. Therefore, almost all trading in U.S.
stocks is done in markets which are linked to a great degree. However, for non-U.S.
stocks, a significant portion of trading may occur in markets that are not tightly
linked.
Another difference between U.S. and non-U.S. stocks is that most non-U.S.
stocks trade in the U.S. in the form of American Depositary Receipts (ADRs).7
ADRs are derivative instruments representing claims on the home market
ordinary shares. A depositary bank (e.g., Bank of New York) purchases the
underlying shares, which are then held by a custodian, and issues a new certifi-
cate, the ADR. This ADR ‘‘looks and feels’’ like a typical U.S. stock: it is
denominated in dollars, trades in the U.S. in dollars, and clears and settles in
the U.S. The depositary bank is responsible for converting dividends into
dollars and for distributing financial statements, further easing any additional
burdens that non-U.S. stocks could place on U.S. investors. These ADRs must
be registered with the U.S. Securities and Exchange Commission, and the
companies are required to reconcile to U.S. Generally Accepted Accounting
Principles (GAAP).
While the converting of underlying shares is perhaps its greatest strength
to investors, as it makes such stocks more easily accessible to U.S. investors,
this conversion poses problems to traders who wish to participate in both the
U.S. and home markets. Generally, ADRs are not fungible, i.e., a U.S. trader
cannot buy the ADR in the U.S. and then sell it in the home market. This
nonfungibility in combination with nonoverlapping trading hours with the
home market increases the risk of holding ADRs. With the NYSE closed and
the home market open, the U.S. investor cannot easily react to changes in
home market prices. Canadian stocks are the main exception to the ADR
format. They are traded in the U.S. as home-market ordinaries, i.e., the stock
traded in Canada is the same as that trading in the U.S. Gande (1997) and
Pulatkonak and Sofianos (1999) provide a more detailed discussion of ADRs and
related securities).8
In addition, different trading rules and regulations across markets may have
an impact on liquidity providers trading non-U.S. stocks. For example,
affirmative and negative obligations imposed upon the NYSE specialist may be
particularly onerous for specialist trading non-U.S. stocks. Also, differences
exist between minimum tick sizes, priority rules, and insider trader restrictions
and regulations. By altering the incentives of liquidity providers, these
differences may alter the nature of liquidity provision across U.S. and non-U.S.
stocks.
7
Our discussion here also applies to Global Depositary Receipts, which are virtually identical in
structure and purpose to ADRs.
8
In 1998, DaimlerChysler listed the first ‘‘global ordinary share’’ based on the Canadian model. This
stock is not included in our sample because its listing occurred after the end of the sample period.
Currently, three non-U.S. stocks trade as global shares on the NYSE (Celanese AG, DaimlerChrysler AG,
and UBS AG).
138 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

3. Theoretical considerations and predictions

In numerous papers, the cost of liquidity is decomposed into three compo-

nents: fixed costs, inventory costs, and adverse selection.9 The difference between
U.S. and non-U.S. stocks may affect these components of liquidity costs
and, consequently, specialist behavior. The use of ADRs, for example, increases
the costs of trading non-U.S. stocks across markets relative to trading U.S.
stocks. Traders in U.S. stocks may be better able to participate across markets
since the markets which dominate trading in U.S. stocks (i.e., U.S. markets)
trade the same (ordinary) security. As such, the increased cost of trading
non-U.S. stocks may lead to greater spread costs. Also, if specialists are less
sensitive to these costs (perhaps due to economies of scale in trading
overseas), specialists could potentially increase their market power (see, e.g.,
Bagehot, 1971; Glosten, 1989; Brock and Kleidon, 1992), resulting in even greater
spread costs.
The inventory component of non-U.S. stocks may also differ from compar-
able U.S. stocks. Domowitz et al. (1998) argue that the partitioning of order
flow across markets makes it more difficult for liquidity providers to interact
with a large portion of the order flow. This difficulty stems from both the use of
ADRs, the lack of interconnectivity across non-U.S. markets, and the fact that
trading hours (or business hours generally) often do not overlap. On the other
hand, non-U.S. stocks may be more liquid (lower fixed and inventory holding
costs) if non-U.S. stocks are able to attract a greater pool of investors and/or
the intermarket competition for trading in non-U.S. stocks is more vigorous.
Indeed, Werner and Kleidon (1996) find that cross-listed British stocks trading as
ADRs on the NYSE had spreads similar to or smaller than those of non-cross-listed
U.S. stocks.
Adverse selection costs for non-U.S. stocks may be larger for multiple reasons.
First, traders in the home market may have an informational advantage relative
to U.S. traders. Choe et al. (2000) and Hau (2000) document such an advantage
for Korean and German traders, respectively, relative to foreign traders. Second,
Domowitz et al. (1998) note that if markets are not perfectly linked informationally,
the presence of arbitrage traders may reduce market quality by increasing the
adverse selection risk borne by liquidity providers. As noted earlier, the vast
majority of trading in U.S. stocks is done in the tightly linked U.S. markets. Trading
in non-U.S. stocks, on the other hand, is done across both the home market and
the NYSE, markets that are not as tightly linked. Consequently, the adverse
selection problem noted by Domowitz et al. is likely to be greater for non-U.S.
stocks relative to comparable U.S. stocks. Third, a similar argument to that of
Domowitz et al. could be made with respect to the existence and enforcement
of insider trading. As noted in Bhattacharya and Daouk (2000), differences in
insider trading restrictions exist across markets and can have a significant effect
on a stock’s cost of capital. Specifically, Bhattacharya and Daouk show that it is

9
See O’Hara (1995) for a discussion.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 139

not simply the existence of insider trading laws that influence trading costs,
but rather the enforcement of these laws. Because the existence of arbitrage
trading will transmit any inside information across markets, non-U.S. stocks should
be less liquid and have greater adverse selection relative to comparable U.S. stocks
despite similar restrictions on insider trading across U.S. and non-U.S. stocks within
the U.S.
Chowdry and Nanda (1991) argue that, in equilibrium, all markets trading a
stock will commit to strict enforcement of insider trading laws. The intuition is
that a market with strict insider trading restrictions will attract uninformed
order flow, which, in turn, will attract informed orders as well. Unless the
competing market also commits to strict enforcement, it will lose order flow to
its competitor. However, since insider trading restrictions do vary across markets
in practice, the results of Domowitz et al. (1998) would suggest that this
could increase the risk of informed trading in both markets (directly via insider
trading in the market with lax enforcement and indirectly via arbitrage trading
in the market with strict enforcement). In the context of our paper, Chowdry
and Nanda’s (1991) results suggest that trading on the NYSE may be more
liquid than trading in the stock’s home market if the home market has lax
enforcement of insider trading laws. However, because we are comparing
NYSE trading in non-U.S. stocks relative to NYSE trading in U.S. stocks, the
ability of informed traders in non-U.S. stocks to trade in foreign markets may
result in greater adverse selection costs for non-U.S. stocks relative to U.S. stocks,
ceteris paribus.
Because differences across stocks affect the cost of liquidity provision, they
should also affect the trading behavior of specialist. The NYSE public
precedence rules make it difficult for specialists to participate in liquid stocks.
If non-U.S. stocks are more liquid due to a larger investor pool, etc., specialist
participation should be relatively low. If the costs of liquidity provision are
high, the affirmative obligations imposed on the specialists (e.g., price conti-
nuity) and their role as ‘‘liquidity provider to last resort’’ may lead to
higher specialist trading in non-U.S. stocks (see Madhavan and Smidt, 1991;
Madhavan and Sofianos, 1998). However, in cases where the costs of making
markets is sufficiently high, specialists may choose to provide less liquidity,
opting instead to bear the costs associated with reduced performance as measured
by the NYSE.10
The testable implications of this discussion are that if liquidity providers view
non-U.S. stocks as being more costly to trade, they may hold less closing
inventory, participate less frequently, and stabilize prices (i.e., buy on downticks
and sell on upticks) less frequently. Alternatively, affirmative obligations may
result in greater participation by specialists, as specialists provide additional

10
The NYSE evaluates the performance of its specialist on an ongoing basis. Superior performance
increases the probability that new NYSE listings will be allocated to the specialist firm. Particularly poor
performance could lead to penalties including, in extreme cases, the re-allocation of a specialist’s stocks.
140 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

liquidity to compensate for the reduced liquidity from other sources.11 Similarly,
with respect to market quality, the fact that most non-U.S. stocks trade as ADRs,
in multiple, weakly-linked markets, during non-overlapping trading hours, etc.,
may lead to less liquidity, as increased fixed costs, inventory holding costs, and
adverse selection costs for non-U.S. stocks translate into wider spreads, less
depth, and greater volatility.12 Alternatively, if non-U.S. stocks are characterized
by greater intermarket competition and a larger pool of liquidity, non-U.S.
stocks may have tighter spreads, more depth, and/or less price volatility than
comparable U.S. stocks.
We should also expect to see differences between non-U.S. and U.S. stocks to be
related to emerging market classification, time zone (i.e., the extent to which the
home market’s business hours overlap with trading hours in the U.S.), and security
type. Domowitz et al. (1998) argue that emerging markets stocks may be traded
differently than U.S. stocks due to differences in inventory holding costs,
intermarket competition, and adverse selection. Furthermore, Pulatkonak and
Sofianos (1999) show that the fraction of order flow in non-U.S. stocks executed on
the NYSE is related to these factors. To the extent that the fragmentation of order
flow across markets influences liquidity costs, we should expect to find similar
patterns in liquidity costs as well.
Another possible conditioning variable is the difference in accounting standards
(see, La Porta et al. 1998). However, the correlation between the accounting
measures used in La Porta et al. and the emerging markets dummy is high
(approximately 0.9). When viewed jointly the accounting variable adds little, if any,
explanatory power, while the emerging market variable retained some incremental
explanatory power. Consequently, we partition solely on whether the stock is from
an emerging market, though we note that any differences between U.S. and emerging
market non-U.S. stocks may stem from differences in accounting standards.

4. Data and methodology

Our sample period covers July 1998, and we include all common stocks listed on
the NYSE as of June 30, 1998 with the following exceptions. We exclude all common
stocks with an average stock price o$1.00 or >$500 per share (to control for
11
In this study, we do not address the issue of whether affirmative obligations are welfare-improving.
Rather, we are attempting to document differences between U.S. and non-U.S. stocks and whether
specialists respond to these differences. Without a more complete characterization of the social benefits of
affirmative obligations, we are only able to draw inferences about the relative costs of affirmative
obligations across groups. For example, even though one main finding of the paper is that trading costs
and volatility are greater for non-U.S. stocks, we cannot conclude that affirmative obligations are
ineffective since we do not know what trading costs and volatility would have been in the absence of
affirmative obligations. See Stoll (1998) for a more complete discussion of specialist affirmative obligations.
12
Kavajecz (1999) notes that greater adverse selection will lead to a reduction in the quoted depth
posted by the specialist and in the limit order book generally. Therefore, if non-U.S. stocks are
characterized by greater adverse selection, they should also have smaller quoted depths.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 141

extreme illiquidity as well as different tick sizes for stocks trading below $1.00). We
also eliminate all stocks that split during our sample by discarding stocks with a
decline of 40% or more overnight since stock splits affect the liquidity of the stock
(see Lipson, 1999).13 Finally, we exclude stocks that trade less than two times per
day, on average, to ensure that our estimates of effective and realized spreads,
volatility, etc. are sufficiently precise.
We identify the non-U.S. stocks using data from the NYSE’s non-U.S. companies
database. This database also identifies the regional classification (America, Europe/
Middle East/Africa, and Asia). The emerging market classifications are taken from
the Emerging Stock Markets Factbook (1997). Some NYSE-listed non-U.S. stocks
are incorporated in locales that do not reflect their true base of operations (e.g.,
Bahamas, Bermuda, etc.). We eliminate these ‘‘flag of convenience’’ stocks since they
trade almost exclusively in the U.S. and do not have a home market (see Pulatkonak
and Sofianos, 1999 for details).
Using the remaining 304 non-U.S. stocks, we construct a matched sample of
U.S. stocks. Specifically, for each non-U.S. stock, we first identify all U.S.
stocks that have the same first three digits of the NYSE industry code. We then
match on the basis of price, market capitalization, and volatility (intraday and
overnight), since previous research has shown these factors influence both
specialist participation and liquidity provision generally (see, e.g., Harris, 1994;
Madhavan and Sofianos, 1998). We match on both intraday and overnight
midquote return volatility because of the fact that some non-U.S. stocks may have
significant overnight price volatility due to trading in the home market (e.g.,
Japanese stocks). We compute the average price and volatility measures using
the NYSE Trade and Quote (TAQ) database. We measure market capitalization
as the total value of equity securities issued at home and abroad. We use global
market capitalization as opposed to the dollar value of shares (ADRs) outstanding
in the U.S. because the number of shares outstanding in the U.S. essentially
reflects U.S. trading activity as opposed to the true size of the company. Generally,
higher (lower) trading volume leads to the creation (cancellation) of additional
ADRs. Market capitalization for U.S. companies was taken from COMPUSTAT,
while data for non-U.S. companies was obtained from the NYSE Non-U.S.
Companies file.
Following an approach similar to Huang and Stoll (1996), we identify a matching
U.S. stock for each non-U.S. stock by determining which U.S. stock minimizes the
following:
!2
X
4
XiU:S:  XiNon-U:S:
 U:S:  ; ð1Þ
i¼1
ðXi þ XiNon-U:S: Þ=2

13
While it is possible that a stock may experience a real depreciation of 40% or more overnight (i.e., one
not solely due to a change in the number of shares outstanding), such an event is extremely rare.
Consequently, it is unlikely that our screen will result in a significant number of volatile stocks being
excluded. Furthermore, because we use price as a matching variable, including such stocks could lead to a
poorly matched sample.
142 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

where XiU:S: denotes the value of the ith matching variable for the U.S. stock, and
XiNon-U:S: denotes the value of the ith matching variable for the non-U.S. stock. This
minimization is done subject to the constraint
 
 X U:S:  X Non-U:S: 
 i i o1
 ð2Þ
 ðXiU:S: þ XiNon-U:S: Þ=2 

for all i (i.e., for each of the four matching variables).14 The constraints are added so
that the resulting matched sample has characteristics which are sufficiently similar to
those of non-U.S. stocks. Given these constraints, we are left with 260 non-U.S.
stocks for which a suitable matched U.S. stock exists.
Using proprietary data from the NYSE’s Specialist Equity Trading Summary
(SPETS) file, we examine three measures: the absolute dollar closing inventory
positions, participation rates, and stabilization rates. We use absolute dollar closing
inventory as opposed to signed inventory because we are concerned with the
magnitude of the exposure as opposed to the direction of this exposure.15 We define
the specialist participation rate as the sum of specialist purchases and sales divided
by total volume (single-counted). The specialist stabilization rate is defined as
specialist buy volume on a downtick plus specialist sell volume on an uptick divided
by total specialist volume. The NYSE uses the specialist stabilization rate in
combination with the participation rate in quantifying the liquidity provision of the
specialist. Whereas the participation rate measures the quantity of specialist
participation, the stabilization rate measures the quality of specialist participation.
A high stabilization rate would be consistent with liquidity provision as the specialist
dampens volatility by ‘‘leaning against the wind’’. Alternatively, a low stabilization
rate would be consistent with active inventory management by specialists, as
specialists demand liquidity more frequently.
To address the market quality issues, we focus on spreads, quoted depth, and
volatility. While these measures are imperfect (see, e.g., Sofianos and Werner, 1997;
Bacidore et al., 2000), they are likely to provide reasonable cross-sectional proxies
for liquidity. We examine time-weighted average quoted spreads, trade-weighted
average effective spreads, the time-weighted average dollar quoted depth at the
prevailing bid and ask (i.e., the sum of the quoted depth on the ask and bid sides of
the market, in dollars, divided by two), and the trade-to-trade midquote return
volatility. The quoted spread is the difference between the prevailing quoted bid and
offer prices and measures the round-trip trading costs for an investor who buys at
the offer and sells at the bid. Because trading on the NYSE provides investors the
opportunity to receive ‘‘price improvement’’, i.e., prices better than the prevailing
bid and offer prices, we also look at the effective spread, defined as twice the absolute
difference between the trade price and the prevailing quote midpoint at the time of
14
Using stricter constraints (i.e., critical values less than one reduced our sample size, but the results
were qualitatively similar.
15
We do all statistical tests involving closing inventory, quoted depth, and trading volume using the
natural logarithms of these variables to control for heteroskedasticity. Because the absolute value of
closing inventory can be zero, we use the logarithm of one plus the closing inventory variable.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 143

the trade. To control for variation in spreads due to any residual differences in price
levels across samples, we focus on percent spreads, i.e., dollar spreads reflected as a
percent of midquote price. Because we initially controlled for intraday and overnight
volatility when creating our matched sample to control for fundamental risk,
comparisons of trade-to-trade midquote volatility should primarily capture
differences in transitory volatility, i.e., the portion of volatility influenced by the
trading process.16
To better address the issue of whether asymmetric information is driving the
differences in spreads, we estimate the realized spread and the corresponding adverse
selection measure as in Huang and Stoll (1996) and Bessembinder (1999). The
realized spread is a measure of the pershare profit accruing to the liquidity provider
as a result of the trade, net of the trade’s price impact. To compute the realized
spread, we first need to identify whether the trade was buyer- or seller-initiated. A
trade at time t is considered buyer- (seller-) initiated if the trade price is above
(below) the midquote. Trades occurring at the midquote are excluded.17 This trade
price is then compared to the midquote price at some point in the future.
More formally, the realized spread for a trade at time t; RSt ; is defined as
(
2ðPt  MtþT Þ if buyer-initiated;
RSt ¼ ð3Þ
2ðMtþT  Pt Þ if seller-initiated;

where Pt is the trade price at time t; and MtþT is the midquote price T minutes
after the trade. Intuitively, the realized spread compares the price the liquidity
supplier paid (received) for the stock relative to its post-trade value, with the
midquote proxying for this value. In computing the realized spread, we set T
equal to 30 min, as in Huang and Stoll (1996) and Bessembinder (1999).18 We
compute the average percent realized spread across all trades for each stock in
our sample.
The adverse selection component of the spread is defined as the difference between
the effective spread (i.e., what investors pay) and the realized spread (i.e., what
liquidity providers earn).19 It is important to separate these two factors since only the
realized spread accrues to liquidity providers. If information asymmetry is more
severe for non-U.S. stocks, we expect non-U.S. stocks to have a larger adverse
selection component. If, however, specialists require additional compensation for
trading in non-U.S. stocks because of non-information based costs (e.g., higher fixed
16
By holding fixed the overnight and intraday volatility, our comparisons of trade-to-trade volatility are
similar in spirit to comparisons of variance ratios across stocks since both the sample stock and its
matching U.S. stock will have the same denominator (or numerator depending on how the variance ratio is
defined). See, e.g., Corwin (1999) for a discussion of variance ratios.
17
While excluding midquote trades may influence the level of our cost estimates, any resulting bias is less
likely to influence our results because we are interested in the difference in realized spreads between U.S.
and non-U.S. stocks. Indeed, if the bias is constant across samples, our estimate of the difference will be
unbiased.
18
The analysis was also done using a 5-min interval. The results were qualitatively similar.
19
Equivalently, the adverse selection component can be computed as the average signed change in the
quote midpoint, which captures the price impact of the trade.
144 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

costs), the realized spread for non-U.S. stocks will be larger than for U.S. stocks. As
with effective and quoted spreads, the realized spread and adverse selection
component are standardized by the quote midpoint (Mt ), thereby giving us the
percent realized spread.

5. Results

5.1. Summary statistics of non-U.S. and matched U.S. sample

Table 1 provides summary statistics for the non-U.S. and matched U.S.
samples. The averages for the matching variables are similar, suggesting that our
matching procedure is effective in identifying a suitable sample of U.S. stocks.
In Section 5.5, we use regression analysis to determine whether our results are
driven by residual differences between our non-U.S. stocks and the matched
sample. Table 1 also provides trading activity statistics for both samples. Even
after controlling for price, market capitalization, industry, and volatility, the
two samples differ considerably with respect to trading activity, with non-U.S.
stocks trading much less frequently than U.S. stocks. While at first blush, one
might consider matching on trading activity, it is important to point out that
these statistics capture only U.S. trading activity, not global trading activity.
Simply having lower trading activity on a given market does not necessarily
imply that the market should be more or less liquid. Furthermore, market share
is endogenously determined by such things as liquidity, and therefore it is
inappropriate to match based on this statistic. However, we match on
global market capitalization, which is used as a proxy for global trading activity
in a stock.
Table 2 contains the mean price, size, volatility, and trading activity broken out by
emerging market classification and by region. Stocks from developed markets
generally have higher prices and greater market capitalization than emerging market
stocks, though the developed market stocks are less volatile on average.
Interestingly, while there are large differences between the trading volume for
developed market non-U.S. stocks and the matched sample of U.S. stocks, the
emerging market stocks have average trading volumes similar to their matched
sample. With respect to regional differences, European stocks have higher share
prices and larger market capitalizations than other non-U.S. stocks. Interestingly,
while the average European stock is almost ten times as large as the average Latin
American stock, the average dollar volume for Latin American stocks is actually
higher.20

20
This result stems entirely from the fact that the U.S. market share is higher in Latin American stocks.
The NYSE estimates that over half of global trading in Latin American stocks was executed in the U.S. in
1998, compared to only 13% for European stocks. As one might expect given the disparities in market
capitalization, the global trading in European stocks is much larger than that for Latin American stocks.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 145

Table 1
Summary statistics for NYSE-listed U.S. and non-U.S. Stocks
This table contains summary statistics for our sample of NYSE-listed stocks for July 1998. Price, volatility,
and trading activity statistics were calculated using the NYSE Trade and Quote (TAQ) database. Market
capitalization is calculated as the value of equity on June 30, 1998. The market capitalization of U.S.
stocks is taken from COMPUSTAT, while the market capitalization for non-U.S. stocks is taken from the
NYSE non-U.S. Companies database.

Sample size U.S. Non-U.S.

260 260

Panel A. All non-U.S. stocks

Price Mean 34.6 31.7
Median 29.5 25.3
Min 1.8 1.5
Max 250.7 137.7

Market capitalization (in dollars) Mean 10,661,652,595 9,702,510,731

Median 2,554,630,000 2,799,725,000
Min 30,964,500 13,250,000
Max 174,041,300,000 121,971,100,000

Open-to-close volatility (in %) Mean 1.90 1.80

Median 1.76 1.64
Min 0.70 0.70
Max 5.70 6.20

Close-to-open volatility (in %) Mean 1.00 1.30

Median 0.93 1.27
Min 0.40 0.30
Max 4.30 4.80

Average daily volume Mean 27,312,808 6,219,997

(in dollars) Median 7,509,067 911,773
Min 15,305 7,248
Max 470,653,047 361,251,840

Average daily number of transactions Mean 224 54

Median 126 24
Min 3 2
Max 2,280 1,103

5.2. Specialist trading

Table 3 contains the results of our comparison of specialist trading behavior.

Overall, specialists hold significantly smaller closing inventories in non-U.S. stocks.
The mean specialist closing inventories are $209,746 for non-U.S. stocks, while the
mean for the U.S. sample is $491,289. This difference is significant at the 1% level,
suggesting that specialist do view non-U.S. stocks differently. Interestingly, though,
 146
Table 2

J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

Summary statistics by emerging market classification and region
This table contains summary statistics for our sample of NYSE-listed stocks for July 1998. Price, volatility, and trading activity statistics were calculated using
the NYSE Trade and Quote (TAQ) database. Market capitalization is calculated as the value of equity on June 30, 1998. The market capitalization of U.S.
stocks is taken from COMPUSTAT, while the market capitalization for non-U.S. stocks is taken from the NYSE Non-U.S. Companies database.

No. of stocks Price MkCap Open-to-close Close-to-open DollVol Number

(in $) volatility (%) volatility (%) (in $) of trans.

Panel A. Developed vs. emerging markets

Developed 173 37.0 13,330,684,104 1.60 1.30 5,896,652 59
Matched U.S. 173 40.0 14,660,553,834 1.80 1.00 37,453,645 288
Emerging 87 21.2 2,487,867,126 2.20 1.30 6,862,972 44
Matched U.S. 87 23.8 2,709,814,497 2.20 1.10 7,147,694 99

Panel B. Regional comparisons

Asia-Pacific 32 27.9 7,027,958,125 1.90 1.90 2,590,841 43
Matched U.S. 32 32.7 8,197,910,303 2.00 1.20 23,370,253 209
Canada 53 27.1 4,866,827,925 1.90 1.00 5,285,403 69
Matched U.S. 53 28.4 5,149,557,798 1.90 0.80 11,839,183 150
Europe 100 44.3 18,865,246,300 1.40 1.60 7,121,846 59
Matched U.S. 100 47.9 20,519,671,935 1.80 1.10 53,113,030 372
Latin America 67 19.0 2,117,812,537 2.20 1.10 7,809,368 43
Matched U.S. 67 21.9 2,635,430,617 2.10 1.00 5,853,342 90
Mid. East/Africa 8 27.5 1,424,772,500 1.70 1.10 2,344,227 30
Matched U.S. 8 23.4 1,028,617,088 2.00 0.90 2,816,032 63
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 147

we find no significant differences in either specialist participation or stabilization

rates between U.S. stocks.
When we split the sample into developed and emerging market stocks, however, a
much richer picture emerges. While both developed and emerging market stocks
have significantly lower mean closing inventories, they differ with respect to
their relative participation and stabilization rates. The participation and stabiliza-
tion rates for emerging market stocks are significantly lower than those of their
matched U.S. sample. For developed markets, on the other hand, the mean
participation and stabilization rates are significantly greater than those of the
matched U.S. sample. Using a sign test, however, the difference in stabilization
rates between U.S. and developed market non-U.S. stocks is not statistically
significant.
The regional analysis provides a similar picture. Specialists hold lower closing
inventories across all regions. Stocks from the European time zone have significantly
higher participation and stabilization rates, while stocks from Latin America have
significantly lower participation and stabilization rates relative to their matched
sample. This result is not surprising since all but eight of the European stocks are
from developed markets, while all of the Latin American stocks are from emerging
markets. Participation and stabilization rates for Canadian and Asia-Pacific stocks,
however, are not significantly different than those of U.S. stocks. Given the
similarities between U.S. and Canadian shares, the results for the Canadian stocks
are not surprising. However, the results for the Asian stocks are difficult to interpret
since these stocks are generally quite different than U.S. stocks (i.e., different home
market trading hours, trade as ADRs, etc.). This result may stem from the small
sample size and/or the fact that the Asian time zone has a more balanced mix of
emerging market and developed market stocks, with about one-third of Asian
stocks coming from emerging markets and two-thirds from developed markets.
However, we find no difference between developed and emerging market stocks
from Asia, though this result may stem from small sample size.21 Nevertheless, the
regional analysis essentially mirrors the results of the developed-emerging market
analysis.
The fact that specialists are less willing to participate and stabilize emerging
market stocks is consistent with Domowitz et al. (1998). The results for developed
market stocks are consistent with specialists being more willing to participate
due to greater liquidity, perhaps because these developed European market
tocks are ‘‘global stocks’’ (e.g., British Airways, Royal Dutch Petroleum, etc.).
Such stocks, it could be argued, have a relatively greater amount of public
information available, which translates into a reduction in adverse selection
and less liquidity. However, the greater participation may be the result of
affirmative obligations imposed on the specialist, with specialists being
encouraged to participate since other liquidity is scarce. Similarly, if the
costs of trading emerging market stocks is sufficiently high, specialists

21
We also used regressions containing region dummies and a single emerging market dummy, but we
again found no significant difference between the Asian stocks and their matched U.S. sample.
 148
J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158
Table 3
Specialist trading behavior in NYSE-listed U.S. and non-U.S. stocks
The data for the analysis are taken from the non-U.S. companies (NUSCOS), Specialist Trading Summary (SPETS). Closing inventory is measured as the
average absolute value of the dollar closing inventory. The participation rate is the sum of specialist buys and sells divided by total trading volume. The
stabilization is the percent of those trades which occurred on a stabilizing tick (i.e., buys on downticks, and sells on upticks).

No. of Average absolute value of closing Participation rate Stabilization rate

stocks inventory (in dollars)

All non-U.S. stocks

Non-U.S. 260 209,746 30.5% 87.2%
Matched U.S. 260 491,289 28.9% 86.7%
Difference (281,543)*** 1.6% 0.5%
% Non-U.S.>U.S. 20.4%*** 47.7% 50.4%

Developed vs. emerging

Developed non-U.S. 173 244,996 33.5% 88.4%
Matched U.S. 173 608,033 28.1% 86.2%
Difference (363,037)*** 5.4%*** 2.2%***
% Non-U.S.>U.S. 19.1%*** 56.6%* 56.1%

Emerging non-U.S. 87 139,652 24.5% 85.0%

Matched U.S. 87 259,141 30.4% 87.7%
Difference (119,490)*** 5.9%*** 2.7%***
% Non-U.S.>U.S. 23.0%*** 29.9%*** 39.1%*
Regional comparisons
Asia-Pacific 32 182,274 31.2% 86.5%
Matched U.S. 32 516,333 29.8% 87.6%
Difference (334,059)*** 1.4% 1.1%
% Non-U.S.>U.S. 12.5%*** 50.0% 40.6%

J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

Canada 53 141,370 26.4% 88.3%
Matched U.S. 53 367,467 28.0% 86.4%
Difference (226,097)*** 1.6% 1.9%
% Non-U.S.>U.S. 18.9%*** 37.7%* 54.7%

Europe 100 306,901 37.8% 88.5%

Matched U.S. 100 757,199 27.3% 85.6%
Difference (450,298)*** 10.5%*** 2.9%***
% Non-U.S.>U.S. 19.0%*** 70.0%*** 61.0%**

Latin America 67 133,372 22.9% 85.1%

Matched U.S. 67 219,737 30.8% 88.1%
Difference (86,366) *** 7.9%*** 3.0%***
% Non-U.S.>U.S. 25.4%*** 22.4%*** 35.8%**

149
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might reduce the level of liquidity provided even though the NYSE provides
incentives to do otherwise. In the next section, we assess differences in liquidity
directly.

5.3. Market quality

Table 4 contains comparisons of quoted and effective spreads, volatility, and

quoted depth. The mean quoted and effective spreads are significantly higher for
non-U.S. stocks than those of the matched U.S. sample. Quoted (effective) spreads
of non-U.S. stocks are 1.17 (0.77)% relative to only 0.69 (0.45)% for the U.S.
sample. Developed market stocks have quoted (effective) spreads of 0.95 (0.63)%,
while the emerging market quoted (effective) spreads are 1.62 (1.04)%. Part of the
difference between developed and emerging market stocks stems from underlying
differences between the two samples, as evidenced by the differences across
their matched samples. The mean quoted (effective) spread for the subsample
of U.S. stocks matched to emerging market stocks is 0.58 (0.38)% relative to
0.89 (0.58)% for the U.S. stocks matched to the developed market stocks.
Nevertheless, the difference between developed market stocks and emerging market
stocks exceed the differences between the matched samples, again consistent with the
conjecture that emerging markets pose particularly difficult problems for liquidity
providers.
As before, we compare these results by region. Here we find both effective and
quoted spreads significantly higher across all regions, even Canada. However, the
difference between the quoted (effective) spread for the Canadian sample and its
matched U.S. sample is only 0.26 (0.18)%, while the difference for the Latin
American sample is 0.77 (0.47)%. Because these two groups share a common time
zone, any differences may stem from the fact that all Latin American stocks are
emerging market stocks. Comparisons between both the Asia-Pacific stocks and
their matched U.S. sample are quite similar to those of the European stocks. Of
course, such comparisons must be made with caution because the stocks in each
region subgroup vary considerably with respect to market capitalization, price, and
volatility. Nevertheless, the results suggest that the emerging market classification is
a more important factor than time zone.
Table 4 also contains comparisons of quoted depths. We find that non-U.S.
stocks have significantly smaller quoted depths. The mean depth for a non-U.S.
stocks is about $105,000, while the mean depth for the matched U.S. sample is
$155,000. Interestingly, the difference in depths is greatest for the developed
market subsample, averaging about $73,000. The mean depth of an emerging
market stock is $88,000 relative to $92,000, a difference of only $4,000 on average.
In fact, if we partition the sample into regions, we find that there is no significant
difference in depth between Latin American stocks and their matched U.S. sample.
We do find significantly smaller depth for both the Asia-Pacific and European
stocks, with Asia-Pacific stocks having about 40% less depth and European
stocks having almost 50% less depth. We find marginally significant differences
between Canadian stocks and their matched sample, and only when using the sign
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 151

Table 4
Market quality statistics for NYSE-listed U.S. and non-U.S. stocks
The data for the analysis are taken from the NYSE Trade and Quote (TAQ) database. Quoted spread is
the time-weighted average quoted spread. Effective spreads are measured as twice the absolute value of the
difference between the trade price and the quote midpoint prevailing at the time of the trade. Both of these
measures are expressed as a percent of the quote midpoint. Midquote volatility is the average trade-to-
trade change in midquote prices. The quoted depth is the average quoted bid and ask depth in dollars.

No. of Quoted Effective Dollar quoted Midquote

stocks spreads (%) spreads (%) depth ($) volatility (%)

All non-U.S. stocks

Non-U.S. 260 1.17 0.77 104,958 0.45
Matched U.S. 260 0.69 0.45 154,889 0.24
Difference 0.49*** 0.32*** (49,931)*** 0.21***
% Non-U.S.>U.S. 86.9%*** 87.7%*** 30.8%*** 88.5%***

Developed vs. emerging

Developed non-U.S. 173 0.95 0.63 113,439 0.36
Matched U.S. 173 0.58 0.38 186,542 0.20
Difference 0.37*** 0.25*** (73,103)*** 0.17***
% Non-U.S.>U.S. 86.1%*** 87.9%*** 27.2%*** 87.9%***

Emerging non-U.S. 87 1.62 1.04 88,095 0.62

Matched U.S. 87 0.89 0.58 91,947 0.32
Difference 0.73*** 0.47*** (3,852)** 0.30***
% Non-U.S.>U.S. 88.5*** 87.4%*** 37.9%** 89.7%***

Regional comparisons
Asia-Pacific 32 1.21 0.83 84,747 0.45
Matched U.S. 32 0.71 0.45 140,010 0.24
Difference 0.50*** 0.38*** (55,263)*** 0.21***
% Non-U.S.>U.S. 96.9%*** 96.9%*** 28.1%** 96.9%***

Canada 53 1.00 0.67 107,560 0.40

Matched U.S. 53 0.74 0.49 119,042 0.25
Difference 0.26*** 0.18*** (11,482) 0.15***
% Non-U.S.>U.S. 75.5%*** 77.4%*** 35.8%* 77.4%***

Europe 100 0.90 0.61 123,572 0.35

Matched U.S. 100 0.47 0.31 232,274 0.16
Difference 0.44*** 0.30*** (108,702)*** 0.19***
% Non-U.S.>U.S. 90.0%*** 91.0%*** 21.0%*** 92.0%***

Latin America 67 1.71 1.08 90,904 0.66

Matched U.S. 67 0.94 0.62 86,207 0.34
Difference 0.77*** 0.47*** 4,697 0.31***
% Non-U.S.>U.S. 88.1*** 88.1%*** 40.3% 89.6%***
152 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

test. These findings suggest that although spreads appear to be driven mainly by
whether the stock is from an emerging market, depth appears to be driven primarily
by time zone, with stocks in the same time zone as the U.S. having depths similar to
those of U.S. stocks.
We also compare the transitory volatility between U.S. and non-U.S. stocks by
comparing the trade-to-trade midquote volatility. As noted earlier, by matching on
open-to-close and close-to-open volatility, we control for fundamental volatility, so
any differences in midquote volatility should reflect differences in transitory
volatility. Differences in midquote volatility would be consistent with less liquidity
for non-U.S. stocks, as order flow leads to greater temporary deviations from
fundamental value. Our results show that non-U.S. stocks tend to be almost twice as
volatile as comparable U.S. stocks. This result holds for both developed and
emerging market stocks and is fairly consistent across regions. Our finding of
increased midquote volatility should not be surprising in light of our findings that
spreads are wider and/or depths are smaller for non-U.S. stocks. Thus, our results
regarding spreads, depths and volatility suggest that non-U.S. stocks are, by and
large, less liquid than U.S. stocks, with the emerging market classification and time
zone influencing liquidity factors in somewhat different ways.

5.4. Decomposition of the spread

Why are spreads higher, all else equal, on non-U.S. stocks? Are liquidity providers
earning larger per share profits or are these spreads higher because U.S. liquidity
providers face larger adverse selection costs? Table 5 contains the results of this
analysis. We find significant differences in adverse selection between U.S. stocks and
non-U.S. stocks, regardless of emerging market classification or region. The smallest
difference exists for Canadian stocks, while the largest differences exist for the
Europe and Asia-Pacific time zones. This finding suggests that the lack of liquidity
across non-U.S. stocks is the result of increased adverse selection costs for non-U.S.
stocks. Furthermore, these findings coupled with those for specialist participation
suggest that perhaps specialists in developed market stocks are being called upon to
participate and stabilize more often as a result of this greater adverse selection,
consistent with Madhavan and Smidt (1991) and Madhavan and Sofianos (1998).
For emerging market stocks, the fact that specialist participate and stabilize less may
be due to higher adverse selection costs, costs which may be sufficiently high that
specialists would rather suffer the consequences of relatively poor performance on
these measures than bear the direct costs associated with price stabilization.
With respect to realized spreads, we find that the realized spreads of non-U.S.
stocks are significantly higher than those of comparable U.S. stocks. This is true for
both the developed and emerging market subsamples, though the result is weaker
for the emerging market subsample. Interestingly, we find differences in realized
spreads across all regions except Latin America, the region with the largest difference
in effective spreads. Differences in realized spreads exist for all other time zones,
suggesting that non-information-based costs are also higher for non-U.S. stocks
as well.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 153

Table 5
Decomposition of the bid-ask spread for NYSE-listed U.S. and non-U.S. stocks
The data for the analysis are taken from the NYSE Trade and Quote (TAQ) data. The realized spread is
measured as two times the difference between the midpoint of the bid-ask spread at the time of the trade
and the trade price multiplied by 1 (1) if the trade was seller- (buyer-) initiated (i.e., occurs below (above)
the midpoint). The adverse selection component of the bid-ask spread is the difference between the
effective and relative spread. Both measures are expressed as a percent of stock price.

No. of Adverse selection Realized

stocks component (%) spread (%)

All non-U.S. stocks

Non-U.S. 260 0.62 0.28
Matched U.S. 260 0.38 0.16
Difference 0.24*** 0.12***
% Non-U.S.>U.S. 75.0%*** 70.0%***

Developed vs. emerging

Developed non-U.S. 173 0.47 0.26
Matched U.S. 173 0.26 0.13
Difference 0.21*** 0.13***
% Non-U.S.>U.S. 70.5%*** 74.6%***

Emerging non-U.S. 87 0.92 0.33

Matched U.S. 87 0.47 0.23
Difference 0.45*** 0.10*
% Non-U.S.>U.S. 83.9%*** 60.9%*

Regional comparisons
Asia-Pacific 32 0.63 0.32
Matched U.S. 32 0.35 0.19
Difference 0.28*** 0.13**
% Non-U.S.>U.S. 75.0*** 71.9%**

Canada 53 0.50 0.27

Matched U.S. 53 0.41 0.18
Difference 0.09*** 0.09**
% Non-U.S.>U.S. 66.0%** 66.0%**

Europe 100 0.97 0.26

Matched U.S. 100 0.50 0.09
Difference 0.47*** 0.16***
% Non-U.S.>U.S. 75.0%*** 78.0%***

Latin America 67 0.46 0.32

Matched U.S. 67 0.29 0.23
Difference 0.17*** 0.09
% Non-U.S.>U.S. 83.6%*** 62.7%*

To summarize, we find that specialists appear to treat non-U.S. stocks differently

than U.S. stocks. Specialists generally hold smaller closing inventory positions in
non-U.S. stocks, regardless of emerging market and region classifications. However,
the extent to which a specialist participates and stabilizes depends on emerging
154 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

market classification and time zone. Specialist participate and stabilize less
frequently in emerging market (Latin American) stocks, and participate and
stabilize more in developed market (European) stocks. Spreads are generally larger
for non-U.S. stocks, with the differences being influenced most heavily by emerging
market classification. Depth, on the other hand, is smaller for stocks whose home
market is in a different time zone than New York, while midquote volatility is larger
for both developed market and emerging market stocks and across all regions. In
sum, we find that non-U.S. stocks are generally less liquid than comparable U.S.
stocks. Finally, we document that differences in spreads are driven primarily by
differences in adverse selection costs between U.S. and non-U.S. stocks, a finding
consistent with Domowitz et al. (1998). We also find evidence that realized spreads
are higher for non-U.S. stocks, though we show in the next section that differences in
realized spread may be due to residual differences between our non-U.S. and
matched U.S. sample.

5.5. Robustness

To determine whether our results are sensitive to residual differences in our

matched sample, we estimate the following regression equation:
dYi ¼ b0 þ b1 d ln Pricei þ b2 d ln MkCapi þ b3 dSigmaIi
þ b4 dSigmaOi þ ei ; ð4Þ
where dYi is the difference between the non-U.S. and U.S. stock statistic being
evaluated (e.g., difference in closing inventory, participation rate, stabilization rate,
etc.) for stock i; dln Pricei is the difference in the logarithm of the average stock
price, dln MkCapi is the difference in log of market capitalization, dSigmaIi is the
difference in standard deviation of open-to-close (intraday) midquote returns over
the previous three months, and dSigmaOi is the standard deviation of overnight
midquote returns measured over the previous three months. We estimate the
regression for developed market and emerging market stocks separately to allow for
any differences in the relationships across samples between the control variables and
the differences in specialist trading and liquidity.22
To test the robustness of our results, we focus on b0 : If our results are not due to
residual differences between our sample non-U.S. stocks and our control U.S.
stocks, then the results of statistical tests on b0 should be consistent with our earlier
findings. However, if differences in our samples do have an influence on our results,
we may find differences when using the regression analysis. The results are presented
in Table 6.23
22
We also estimate the model to control for differences across samples with respect to whether the
stocks were Rule 19c-3 stocks, whether the stocks were newly listed in 60 days, and whether the stock had
options traded on them (Madhavan and Sofianos, 1998). In addition, we estimate a similar model which
included specialist dummy variables to determine whether the results were driven by differences across
specialist firms trading non-U.S. stocks, as in Corwin (1999). The results were qualitatively similar.
23
Statistical tests were also done using a White (1980) heteroskedasticity-consistent covariance matrix.
The results were qualitatively similar.
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 155

Table 6
Cross-sectional regression analysis
Cross-sectional regressions are estimated using the difference between specialist activity variables and
market quality variables of non-U.S. and matching U.S. stocks as dependent variables. The independent
variables are the differences in the matching variables. Specifically, the dependent variables are the
differences in the natural logarithm of absolute closing inventory, participation rates, stabilization rates,
percent quoted spreads, percent effective spreads, volatility of trade-to-trade midquote returns, natural
logarithm of average quoted depth, percent realized spread, percent effective spread, and percent adverse
selection component. The independent variables are the differences in the natural logarithm of price, the
natural logarithm of global market capitalization, the difference in open-to-close return volatility, and
close-to-open return volatility. P-values are given in italics.

Closing PartRate StabRate QSprd ESprd Depth MidVol RealSprd Adverse

inventory selection

Panel A. Developed market stocks

Intercept 0.971 0.030 0.028 0.218 0.135 0.312 0.118 0.028 0.111
0.000 0.186 0.011 0.000 0.000 0.001 0.000 0.374 0.004
Dlnprice 0.638 0.122 0.010 0.386 0.263 0.104 0.122 0.230 0.083
0.026 0.006 0.658 0.001 0.000 0.547 0.022 0.000 0.260
Dlnmkcap 0.002 0.000 0.011 0.051 0.034 0.341 0.039 0.086 0.054
0.993 0.994 0.591 0.609 0.564 0.033 0.418 0.129 0.425
Dinvol 72.429 2.815 3.676 8.538 1.303 24.923 6.098 11.907 16.939
0.000 0.306 0.007 0.211 0.745 0.022 0.067 0.002 0.000
Dovvol 24.307 10.190 3.500 30.316 22.884 33.163 12.405 11.826 14.930
0.300 0.005 0.050 0.001 0.000 0.020 0.005 0.020 0.014

Panel B. Emerging market stocks

Intercept 0.648 0.051 0.026 0.483 0.274 0.118 0.246 0.023 0.340
0.000 0.012 0.032 0.000 0.002 0.226 0.000 0.740 0.000
Dlnprice 0.465 0.033 0.014 1.072 0.743 0.531 0.264 0.421 0.500
0.179 0.447 0.579 0.000 0.000 0.012 0.003 0.006 0.005
Dlnmkcap 0.533 0.020 0.047 0.151 0.058 0.408 0.051 0.238 0.072
0.117 0.633 0.059 0.572 0.748 0.047 0.543 0.108 0.675
Dinvol 6.828 4.557 0.966 12.112 6.341 7.094 12.656 12.337 19.880
0.724 0.062 0.494 0.430 0.540 0.543 0.010 0.145 0.045
Dovvol 26.871 1.238 3.972 6.600 13.164 17.908 1.457 15.974 3.352
0.341 0.725 0.055 0.767 0.381 0.292 0.835 0.193 0.814

Panel A of Table 6 shows that for developed market stocks, most of the inferences
drawn from the earlier analysis hold even after controlling for differences across the
two samples. However, two notable exceptions exist. First, there is no longer a
significant difference in participation rates between developed market non-U.S.
stocks and U.S. stocks. Nevertheless, the differences in closing inventory and
stabilization persist, suggesting that specialists do treat non-U.S. stocks differently.
Second, the difference in realized spreads is no longer significant, though the
difference in adverse selection remains significantly different from zero. This suggests
that the difference in realized spreads stems from differences in the samples as
opposed to real differences in the non-information component of liquidity provision
costs.
156 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158

Panel B of Table 6 contains the results for the emerging market stocks. With
respect to specialist trading, the regression analysis confirms our earlier findings.
However, while our results for spreads and volatility are also consistent with our
earlier findings, we do not find any significant differences between quoted depth
across the emerging market and U.S. subsamples. Nevertheless, the fact that spreads
(and volatility) are higher for emerging market stocks is consistently with less
liquidity because, although the amount of depth is similar, the cost of that depth is
greater for non-U.S. stocks (Lee et al., 1993).
Panel B of Table 6 also confirms our earlier findings with respect to adverse
selection. However, as with developed market stocks, we find no significant
difference in realized spreads. This suggests that our realized spread results may be
due to residual differences across our sample of non-U.S. stocks and the control
sample of U.S. stocks. Of course, an alternative explanation is that splitting the
sample reduces the power of the tests employed. Nevertheless, we conclude that the
differences in spreads is primarily due to differences in adverse selection, and there is
only weak evidence that realized spreads are larger for non-U.S. stocks.
We also estimate Eq. (4) for each region (results not reported). By and large, the
results of the regression analysis confirm our earlier findings. The only significant
differences are that quoted spreads and the adverse selection component for
Canadian stocks are no longer significantly different than U.S. stocks (though
effective spreads remain significantly larger). For European stocks, the stabilization
rate is no longer significantly different than the stabilization rate for U.S. stocks. The
only major consistent difference is that the realized spread for all regions is no longer
significant, suggesting the difference in effective spreads between U.S. and non-U.S.
stocks is due to differences in adverse selection. Again, this difference could also be
due to a reduction in power as the sample is spread out over a greater number of
regressions.

6. Conclusions

For policy purposes, the most important finding of this paper is that the observed
differences in market quality and specialist trading between U.S. and non-U.S.
stocks are due to greater information asymmetries associated with trading non-U.S.
stocks. Any policy action reducing these information asymmetries would likely
improve the market quality of NYSE-traded non-U.S. stocks. If the NYSE were to
extend trading hours, as it is proposing, the resulting increase in time zone overlap
with the trading hours of non-U.S. markets may reduce information asymmetries
and improve market quality. Strengthening the linkages between the NYSE and non-
U.S. markets may also reduce the adverse selection costs. Similarly, a global
regulatory effort to reduce the disparities in insider trading restrictions in different
markets by reducing information asymmetries may improve market quality.
Our findings also suggest that the observed differences in specialist trading
between U.S. and non-U.S. stocks are not the cause of differences in market quality.
Rather, they may be caused by the same factors generating differences in market
 J.M. Bacidore, G. Sofianos / Journal of Financial Economics 63 (2002) 133–158 157

quality: increased information asymmetries. Blaming and penalizing the specialists

for the lower market quality in non-U.S. stocks is unfair because these stocks are
intrinsically more difficult to trade. Encouraging the concentration of non-U.S.
stocks in particular specialists may be a useful way to reduce information
asymmetries. A specialist ‘‘specializing’’ in Mexican stocks, for example, will have
strong incentives to develop ties with the home market including, possibly, an
association with local broker-dealers.

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