DP19008 Missing Markets: Microstructure and Liquidity on the 19th Century London Stock Exchange
This paper studies the behavior of specialist dealers in choosing to make markets in securities. Our setting is the 19th century London Stock Exchange and the universe of securities listed on the exchange in the 1870s. The LSE was a free-entry dealer market, where dealers were free to choose which securities to deal in. In this context, we show that up to 80% of securities were orphaned with no specialist offering immediate execution. In line with the findings of recent literature, our estimates show that specialist dealers concentrated their market-making in the most liquid securities. A combination of adverse selection and inventory costs prevented the development of liquid markets in most securities, with dealers opting instead to provide match-making services. Our findings are consistent with recent research on the possibility of liquidity bifurcation and market fragility.
