Making Many Markets: Limited Attention and the Allocation of Effort in Securities Trading

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Abstract
Individual market makers often provide liquidity for a portfolio of stocks. Although this organizational arrangement may yield public benefits through diversification or subsidization, theories of limited attention suggest that it may also impose important constraints. We examine individual NYSE specialist portfolios and find that the execution quality of a stock is inversely related to the total trade frequency of other stocks handled by the same specialist, especially for the least active stocks. We interpret our results as evidence that market makers face time and processing limits, and that they allocate effort toward their most active stocks during periods of increased trading activity. This, in turn, forces the market maker to reduce their attention to the other stocks in their portfolio, leading to a decrease in execution quality for these stocks. This research has policy implications regarding the structure of trading floors and the use of automatic execution systems.

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