Market Microstructure -Why do prices rise? - Because there are more buyers than sellers! 26 октября 2002 Стратегии
Plan Why is the organization of trading process important for investors? n Buying and selling – Short sales – Margin and leverage effect n Classification of financial markets – Primary vs secondary markets – Exchange vs OTC markets NES FF 2005/06 2
Examples n Ticks – 1/8 vs 1/32 vs decimal n Price over 100 – Stock splits n Analyst recommendations – Conflict of interests n Failure of LTCM NES FF 2005/06 3
Market participants n Brokers – Trading on behalf of a client n Dealers – Trading for their own account n Market-makers – Providing bid-ask quotes NES FF 2005/06 4
Placing an order Market n Limit n Short sale n – ‘Selling a cow, which you don’t own’ – Borrow a stock from (another client of) your broker n Stop loss/buy – Conditional market order: to lock in gains NES FF 2005/06 5
Margin trading n Initial / maintenance margin – % of MV(assets) kept in the account as collateral – The rest is borrowed from the broker n Margin call – If the amount in the account drops below maintenance margin n Leverage effect: r = (ΔP - interest) / (P 0 margin) NES FF 2005/06 6
Classification of financial markets n Bank credits – Commercial vs Interbank n Foreign exchange (FX) – Spot / forward exchange – Deposit-loan • • National markets Euro markets NES FF 2005/06 7
Classification of financial markets (2) n Security market – Primary – Secondary • Exchange: – NYSE, LSE (stocks) – CBOT, LIFFE (derivatives) • OTC (over-the-counter) – NASDAQ NES FF 2005/06 8
Desirable characteristics Informational transparency n Min transaction costs n Liquidity n – Ability to open or close large positions without strong effect on prices – Tightness / depth / resiliency n Informational efficiency – Speed of incorporating information to prices NES FF 2005/06 9
Market architecture n Degree of continuity – Periodic vs continuous systems n Reliance on market makers – Auction / order-driven market – Dealer / quote-driven market: market maker takes the opposite side of every transaction n Degree of automation – Floor vs screen-based electronic systems NES FF 2005/06 10
Market architecture (2) n Protocols – – n Choice of minimum tick Rules to halt trading, circuit breakers Transparency: providing info before (quotes, depths) and after (actual prices, volumes) trades – Extent of dissemination: brokers, customers, or public – Speed of dissemination: real time / delayed feed – Degree of anonymity: hidden orders, counterparty disclosure – Permitting off-exchange / upstairs trading FF 2005/06 NES 11
Basic trading systems n Batch auction / call market: NYSE open – Agents submit demands to the auctioneer who sets common market clearing price n Continuous auction: NYSE intraday, Euronext – Floor: brokers trade with each other on behalf of their clients – Electronic: the system displays the best limit orders and automatically executes incoming market orders n Dealership market: NASDAQ – Market-makers provide bid and ask prices at which other agents may trade NES FF 2005/06 12
Stock exchange vs OTC Stock exchange OTC Auction Dealer market One center Different locations Access only for members Much wider membership Listing with strong requirements No or weaker for companies requirements Bid/ask quotes or Quoting: a single price limit order book FF 2005/06 NES 13
NYSE vs NASDAQ NES FF 2005/06 14
Recent developments n n Trading online Exchange-traded funds (ETFs) – Mimick indices – E. g. , Cubes, Spiders, Diamonds n Electronic Communication Networks (ECNs) – Automated systems for disclosing / executing trades n Program trading NES FF 2005/06 15
Structural shifts n Technological innovations n Substantial increase in trading volume n Competition between exchanges and ECNs n Proliferation of new financial instruments NES FF 2005/06 16
Regulation of stock trading n Circuit breakers – Restrictions on trading if prices reach a threshold n Legislation – – – n Firms: public disclosure of relevant info Employees: no insider trading Market participants: fair trading Monitoring by SEC – Key divisions: Corp. Fin, Mkt. Regulation, Enforcement NES FF 2005/06 17
Market microstructure models n Price formation / discovery – How prices impound info over time – Determinants of trading costs n Market structure and design – Trading process vs price formation NES FF 2005/06 18
Market microstructure models (2) n Transparency – Info and disclosure n Interaction with other areas in finance – Corp. Fin: IPO underpricing, stock splits – Asset Pricing: liquidity as risk factor, anomalies vs trading costs – Intl. Fin: ADRs, cross-border flows NES FF 2005/06 19
Selected issues n What are the components of the bid-ask spread? – Risk aversion – Inventory control – Info asymmetry n Why is trading concentrated at the opening and closing? – Optimal choice of timing the transaction by uninformed NES FF 2005/06 20
Selected issues (2) Is continuous bilateral system better than periodic multilateral one? n Is it good for a stock to be traded in several markets? n – Gravitation vs stratification Should the limit order book be displayed in public? n How to execute block trades optimally? n NES FF 2005/06 21
Conclusions You make more selling information than following it 26 октября 2002 Стратегии
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