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Information Disclosure and Market Quality:
The Effect of SEC Rule 605
on Trading Costs
Xin Zhao and Kee H. Chung
Recent changes in disclosure rule
Regulation Fair Disclosure (Reg FD) –
October 2000
 NYSE’s OpenBook – September 28, 2001
 NASDAQ’s SuperMontage – October 11,
 SEC Rule 605 – May 1, 2001
 SEC Rule 606 – January 30, 2001
Regulation Fair Disclosure
Mandated that all publicly traded companies
must disclose material information to all
investors at the same time.
 The regulation sought to stamp out
selective disclosure.
 Regulation FD changed fundamentally how
companies communicate with investors, by
bringing better transparency and more
frequent and timely communications,
perhaps more than any other regulation in
the history of the SEC.
NYSE’s OpenBook
NYSE OpenBook provides a real-time view
of the Exchange's limit-order book for all
NYSE-traded securities.
 Traders see aggregate limit-order volume
at every bid and offer, thus raising the
NYSE market to an even greater level of
 NYSE OpenBook is available via an
electronic data feed or via market data
vendor services.
NASDAQ’s SuperMontage
The SuperMontage is NASDAQ's trading
system to aggregate quotes and orders,
providing access to more possible trades.
 The key features include pre-trade
anonymity, the ability to aggregate interest
five price levels deep on each side of the
 A high level of confidence of best execution
for users.
SEC Rule 605 and 606
Increase the visibility of execution quality
of the U.S. securities markets for public
 Market centers that execute investor
orders are required to make monthly
disclosures of information on execution
quality. Present study
 Broker-dealers will be required to disclose
the identity of the market centers to which
they route orders on behalf of customers.
Our findings on Rule 605
The effective and quoted spreads declined
 The decline cannot be attributed to a trend
in spreads, concurrent changes in stock
attributes, or decimal pricing.
 Although the quoted depth of NYSE stocks
also declined, overall market quality is
higher after implementation of the Rule.
 The SEC’s goal to improve execution quality
through more transparent markets has been
What is Rule 605?
The SEC adopted Rule 605 on November
15, 2000.
 The Rule requires market centers to make
monthly public disclosure of execution
 The Rule is intended to achieve a more
competitive and efficient national market
system by increasing the visibility of
execution quality.
To facilitate comparison across market
centers, the Rule adopts basic measures of
execution quality.
 For each security, the statistical information
is categorized by five types of orders and
four order size groups.
 For market orders and marketable limit
orders, the Rule requires market centers to
report effective spreads and price
improvement rates.
 The Rule requires all market centers to post
monthly order-execution reports on their
What are market centers?
The term "market center" is defined as
"any exchange market maker, OTC market
maker, alternative trading system, national
securities exchange, or national securities
 Market centers that trade NMS securities
are required to make monthly electronic
disclosures of information regarding
execution quality on a stock-by-stock basis.
Prior studies
Boehmer (2005) performs a post-decimal
comparison of market quality between NYSE and
NASDAQ securities.
He, Odders-White, and Ready (2005) compare
effective and realized spreads for marketable
orders in NYSE-listed and NASDAQ stocks.
Boehmer, Jennings, and Wei (2005) investigate
whether brokers and traders use Rule 605 data in
order-routing decisions.
Lipson (2004) examines competition among six
market centers for NYSE-listed stocks using Rule
605 data.
Boehmer, Saar, and Yu (2005) examine
the effect of pre-trade transparency on
market quality by analyzing the NYSE's
OpenBook service.
 Bessembinder, Maxwell, Venkataraman
(2006) analyze the effect of post-trade
transparency on market quality in
corporate bond markets.
Research design
Market centers have an incentive to
improve their execution quality for month t,
although it will be available by the end of
month t + 1.
 We assume that market centers’
adjustment to the Rule would be completed
by the end of month t + 1.
 We define months t and t + 1 as the event
period, months t – 2 and t – 1 as the prerule period, and months t + 2, t + 3,…, t +
N as the post-rule period, where N is set
large enough to capture the full effect of
the Rule.
NYSE and AMEX samples
For the 1,000 most active NYSE securities
and 200 most active AMEX securities, we
consider March and April 2001 as the prerule period.
 To measure the short- and long-term
effects, we consider the following two
post-rule periods: July and August 2001
(PostS) and July, August, October,
November, and December 2001 (PostL)
NASDAQ sample
We consider July and August 2001 as the
pre-rule period.
 Two post-rule periods: December 2001 and
January 2002 (PostS) and December 2001
through March 2002 (PostL).
 We do not include September 2001 in the
post-rule period for NYSE securities and in
the pre-rule period for NASDAQ securities
because of the September 11, 2001 attack.
Market quality measures
The average effective and quoted spreads of NYSE
stocks declined by more than 20%.
Although the average quoted depth of NYSE stocks
also declined, the post-rule market quality is better
than the pre-rule market quality.
For the AMEX study sample, the effective and
quoted dollar spreads declined by more than 20%
while the quoted depth increased by more than
20%. We find significant reductions in NASDAQ
spreads as well.
We conclude that the SEC’s goal to improve
execution quality through more transparent
markets has been achieved.