Abstract not found

Abstract not found

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...

This paper is a substantially revised version of a paper included in

This paper presents a parsimonious model of a specialist choosing prices and depths jointly in order to maximize profits. The model delivers many of the empirical results concerning posted spreads and depths found in the literature. Specifically, the model predicts that (1) spreads will widen and depths will fall in response to an increase in the amount of adverse selection, (2) spreads will widen and depths will remain unchanged in the wake of an increase in price uncertainty, and (3) prices will shift upward and depth will be shifted from the ask side to the bid side of the market in the event that either expectations become more optimistic or the percentage of desired sales by liquidity traders increases. Furthermore, the constrained models show that prices and depths are used as substitutes. In particular, a narrow bid-ask spread induces small depth quotes whereas large depth quotes induce a wide bid-ask At the most basic level, the study of how assets are traded in financial markets must include an analysis of both the price and quantity components of an asset’s posted supply and demand schedules. These schedules typically take the form of bid and ask prices as well as volume quotations or depths. There has been a considerable amount of research on the price component of these posted supply and

this paper, we examine the impact of market activity on the percentage bid-ask spreads of S&P 100 index options using transaction data. We propose a new market microstructure theory called a derivative hedge theory, in which option market percentage spreads will be inversely related to the option market maker's ability to hedge his positions in the underlying market, as measured by the liquidity of this underlying market. In a perfect hedge world, spreads arise from the illiquidity of the underlying market, rather than from inventory risk or informed trading in the option market itself.

on New Financial Market Structures, and the Federal Reserve Bank of New York, for helpful comments. The views stated here are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of New York, or the Federal Reserve The Microstructure of Cross-Autocorrelations This paper examines the specific mechanism by which the incorporation of information into prices leads to cross-autocorrelations in stock returns. We develop a model where trading on private information occurs first in the large stocks and is transmitted to small stocks with a lag. Such trading reduces large stock liquidity, so that, in equilibrium, greater large stock illiquidity portends stronger cross-autocorrelations. Empirically, we find that the lead-lag relation between large and small stocks increases with lagged spreads of large stocks. Further, order flows in large stocks significantly predict returns of small stocks when large stock spreads are high, at both the market and industry levels. In addition, the role of order flow and liquidity in predicting small stock returns is stronger prior to macro announcements (when information-based trading is more likely)

Abstract: Extreme adverse selection arises when private information has unbounded support, and market breakdown occurs when no trade is the only equilibrium outcome. We study extreme adverse selection via the limit behavior of a financial market as the support of private information converges to an unbounded support. A necessary and sufficient condition for market breakdown is obtained. If the condition fails, then there exists competitive market behavior that converges to positive levels of trade whenever it is first best to have trade. When the condition fails, no feasible (competitive or not) market behavior converges to positive levels of trade.

This article presents a microstructure model of liquidity provision in which a specialist with market power competes against a competitive limit order book. General solutions, comparative statics and examples are provided first with uninformative orders and then when order flows are informative. The model is also used to address two optimal market design issues. The first is the effect of “tick ” size — for example, eighths versus decimal pricing — on market liquidity. Institutions trading large blocks have a larger optimal tick size than small retail investors, but both prefer a tick size strictly greater than zero. Second, a hybrid specialist/limit order market (like the NYSE) provides better liquidity to small retail and institutional trades, but a pure limit order market (like the Paris Bourse) may offer better liquidity on mid-size orders. The provision of liquidity is the raison d’être for organized financial markets. 1 Investors value liquidity because it facilitates better risk sharing and encour-I thank Praveen Kumar for many invaluable discussions and Franklin Allen

I am grateful to seminar participants at the Dealer Markets Conference at Ohio