Optimal stock allocation in specialist markets

In this paper we investigate the optimal allocation of stocks in specialist markets. We distinguish two allocation rules; allocation of stocks to different specialists and random allocation. Which rule is optimal depends on the correlation of the stocks. Random allocation is preferred by specialists if the correlation between the stocks is above a certain positive threshold, while investors prefer the random allocation for stocks with a negative correlation. The threshold above which specialists prefer random allocation depends on their market share. Evidence from the allocation of new listings on the NYSE supports our result that the allocation procedure used favors specialists.