How do designated market makers create value for small-caps. Working paper, Vrije Universiteit

University Amsterdam for a VU talent grant. How Do Designated Market Makers Create Value for Small-Caps? A poor liquidity level and a high liquidity risk raise the cost of capital for small-cap firms. Euronext allows them to contract with designated market makers (DMMs) who commit to supply a minimum liquidity at all times. We conduct an event study focused on 74 firms that sign up for DMMs. We find that the contract improves the liquidity level, reduces the liquidity risk, and generates an average cumulative abnormal return of 3.5%. It seems that shareholders willingly pay a DMM fee to insure against idiosyncratic future trading needs at times of low endogenous liquidity. Empirically, we find that DMMs participate in more trades and suffer a trading loss on high quoted spread days. That is, on days when their constraints are likely to bind. Financial market development and economic growth are related. Rajan and Zingales (1998) provide evidence to suggest a causal relationship from financial market development to growth. Levine and Zervos (1998) emphasize stock market liquidity as an important at