Traditionally and understandably, the microscope of market microstructure has focused on attributes of single assets. Little theoretical attention and virtually no empirical work has been devoted to common determinants of liquidity nor to their empirical manifestation, correlated movements in liquidity. But a wider-angle lens exposes an imposing image of commonality. Quoted spreads, quoted depth, and effective spreads co-move with market- and industry-wide liquidity. After controlling for wellknown individual liquidity determinants, such as volatility, volume, and price, common influences remain signi"cant and material. Recognizing the existence of commonality is a key to uncovering some suggestive evidence that inventory risks and asymmetric information both affect intertemporal changes in liquidity.

This paper explores the competition between two trading venues, Electronic Communication Networks (ECNs) and Nasdaq market makers. ECNs o¡er the advantages of anonymity and speed of execution, which attract informed traders. Thus, trades are more likely to occur on ECNs when information asymmetry is greater and when trading volume and stock-return volatility are high. ECN trades have greater permanent price impacts and more private information is revealed through ECN trades than though market-maker trades. However, ECN trades have higher ex ante trading costs because market makers can preference or internalize the less informed trades and o¡er them better executions. TECHNOLOGICAL INNOVATIONS THAT ENABLE HIGH-SPEED, low-cost electronic trading systems are dramatically changing the structure of ¢nancial markets. Exchanges and markets around the world are merging or forming alliances to improve liquidity and reduce costs in the face of increased competition from each other and from these computerized trading systems.Trading volume on Electronic Communications Networks (ECNs) has grown rapidly over the past several years. ECNs are now involved in more than a third of Nasdaq trading volume and are attempting to increase their market share in NYSE-listed

Exchange for providing the requisite data, and Lawrence Glosten and an anonymous reviewer for their extensive and insightful comments and suggestions. This paper is dedicated to Teppo Martikainen who contributed substantially to earlier versions of this paper but did not live to witness its completion.

This paper studies Nasdaq market makers' activities during the one-and-half hour pre-opening period. Price discovery during the pre-opening is conducted via price signaling as opposed to the auction used to open the NYSE or the continuous market used during trading. In the absence of trades, Nasdaq dealers use crossed and locked inside quotes to signal to other market makers which direction the price should move. Furthermore, we #nd evidence of price leadership among market makers that bears little resemblance to their IPO#SEO lead underwriter participation. A fundamental issue in the study of market microstructure is the process through which new information is incorporated into security prices. Several mechanisms are known to exist. They include continuous markets, auction markets, price experimentation, and price signaling. The #nance literature has studied continuous markets extensively. For example, numerous theoretical papers have developed structural models which provide i...

Eric Sirri, Andrei Shleifer, and an anonymous referee for helpful comments. We acknowledge

remaining errors are our responsibility alone. 0 The Informational Content of Option Volume Prior to Takeovers This paper examines informed trading in the options versus the stock market prior to takeover announcements. Prior to an announcement, the percentage increase in call volume for target firms is roughly four times as large as the increase in stock volume. Moreover, preannouncement option volume is the heaviest in those takeover targets that experience the highest announcement-day returns. Short-term out-of-the-money calls experience the largest increase in buy-side trading, suggesting that the activity is dominated by those who are relatively certain an announcement will occur soon. We also use volume-triggered trading rules to further assess the relationship between call volume and future returns as well as the profitability of option trading prior to takeovers. Trading profits are increasing in the amount of call volume required to trigger a buy signal. However, similar trading rules using stock volume reveal no such patterns. When these trading rules are applied to all firms with options listed on the CBOE, large increases in call-option trading are again followed by higher subsequent returns. Our results indicate that between the options and the stock markets, informed investors prefer to trade on the former market. Thus, the options market is more conducive to information and price discovery. 1 1

positions of government bond dealers. We are very grateful to Richard Brealey, Allison Holland, Francis Longstaff and John Merrick for detailed discussions. We are also grateful to an anonymous referee, Yakov

the NBER Market Microstructure meeting, and the NYSE for helpful comments. We thank the NYSE for providing system order data. WHICH SHORTS ARE INFORMED? We use a long, recent panel of proprietary system order data from the New York Stock Exchange to examine the incidence and information content of various kinds of short sale orders. On average, at least 12.9 % of NYSE volume involves a short seller. As a group, these short sellers are extremely well-informed. Stocks with relatively heavy shorting underperform lightly shorted stocks by a risk-adjusted average of 1.07 % in the following 20 days of trading (over 14 % on an annualized basis). Large short sale orders are the most informative. In contrast, when more of the short sales are small (less than 500 shares), stocks tend to rise in the following month, indicating that these orders are uninformed. We partition short sales by account type: individual, institutional, member-firm proprietary, and other, and we can distinguish between program and non-program short sales. Institutional non-program short sales are the most informative. Compared to stocks that are lightly shorted by institutions, a portfolio of stocks most heavily shorted by institutions on a given day underperforms by a risk-adjusted average of 1.36 % in the

This paper investigates whether dealer firms' trading and pricing decisions are governed by their equivalent inventories, based on total returns as in Ho and Stoll (1983) or on unhedgeable returns as in Froot and Stein (1998), or by their ordinary inventories, as would be the case in a decentralized market-making organisational structure. It finds that ordinary inventories, and not equivalent inventories best explain dealer firms' quote placement strategy, which dealer firm executes trades and the qua lity of execution offered to the trades. This finding is consistent with decentralized market making where, due to information sharing difficulties or the nature of compensation contracts, individual dealers care only about risk of stocks managed by them, and not the positions of other dealers within the firm.

We study the trading of individual investors using transaction data and identifying buyeror seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns.