Download FMA Doctoral Consortium Market Microstructure

FMA Doctoral Consortium
Market Microstructure
Larry Harris
USC and SEC
October 16, 2002
San Antonio
An Introductory Caution
• Data resources in market
microstructure are especially
strong and seductive.
• Data mining can be very
productive.
– But you can never fully satisfy the
referee.
Tools and Problems
• Problem-oriented approaches are
most interesting and satisfying.
• Tools versus problems
Positive and Normative
Economics
• Trader behavior depends on market
structure.
• Choosing the best market structure
depends on trader behavior.
Trader Behavior
• Buy-side traders
• Gamblers
• Dealers
• Bluffers
• Order anticipators
• Informed traders
Buy-side Order Strategy
• How Should Traders Trade?
– Break up orders?
– Timing?
– Limit or market?
– Display or hide?
• Theory on these questions has been
started but good empirical work is
still scarce.
Buy-side Order Strategy
• Search strategies depend on
trading problems.
• We don’t know very much about
trading problems.
• Why do people trade?
Buy-side Order Strategy
• Trading is a search problem.
• We need better models of the time
dimension of liquidity.
– Liquidity is more than bid/ask spread.
• Empirical studies focus too much on
market order traders.
Gamblers
• CBOE’s “Power paks”
• Long-term relation between
informed prices and uninformed
traders.
Dealer Behavior
• Generally well worked over.
• We need to better understand the
relation between dealing and shortterm speculation.
Bluffers and Manipulators
• Bluffers make the provision of
liquidity “efficient.”
• Derivative pricing problems.
– Cash settlement.
– Crossing markets
Order Anticipators
• Traders can profit from serially
correlated order flows.
• What causes serially correlated
order flows?
• Should this be regulated?
Informed traders
• Value traders
– Winner’s curse
• News traders
– How do you know whether the
information is in the price?
• Limits to arbitrage
Market Structure
• Best markets
• Problems with competition
• Regulatory issues
What Market Structure
Is Best?
• Continuous versus batch
mechanisms.
• Electronic versus open outcry.
• Order-driven public auction
markets versus quote-driven dealer
markets.
• Segmentation versus consolidation.
Analytic Issues
• Theoretical comparisons must
model endogenous order flows.
• Empirical comparisons must keep
everything else constant.
– Side-by-side comparisons must model
clientele issues.
Market Criteria
• Of what benefit are informative
prices over short horizons?
• Of what benefit are continuous
markets?
How Do We Tradeoff…
• Fast versus slow markets?
• Simplicity and complexity?
• Dealers versus limit order traders?
• Competition for best price and
competition in exchange services?
Regulatory Issues
• Agency problems with brokers.
• Order-flow externality.
• How should we regulate trading in
general?
• Who should pay for regulation?
• What is the value of innovation?
• Specialists
Economics of Coordination
• Externalities
• Problems
– Market data fees
– Trade-through rules
– Transparency
– Secondary precedence rules
– Circuit breakers
Agency Problems
• Payments-for-order flow
• Penny stock problems
– Whack-a-mole
• Churning
– Client suitability
Current Issues
• Analysts
– What is the value of advice in a zerosum game?
• IPO problems
• What is an exchange?
• Market center fees
• Fast, slow and traded through
Related Topics
• Liquidity and asset pricing
– The mutual fund problem
• Liquidity and contract design
– Where is the line between public
financing and private financing?
• Macro- and micro- concepts of
liquidity.
Conclusion
• Very exciting time to work in
Finance.
• Still lots of good topics.
• Good luck!
Read the Press
• SEC web page
• Securities Week
• Pension and Investments Age
• Investment Dealer’s Digest