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Competition, Division and Unity: The Impact of Market Structures on Trading Quality
Stockholms universitet, Samhällsvetenskapliga fakulteten, Företagsekonomiska institutionen.ORCID-id: 0000-0002-2803-5753
2024 (Engelska)Doktorsavhandling, sammanläggning (Övrigt vetenskapligt)
Abstract [en]

The financial market operates as an ecosystem, involving diverse yet interconnected marketplaces and participants. Market design, intricately interacting with technology, regulation, and competition, shapes how participants adapt their trading behavior and therefore influences market performance. This dissertation investigates how market microstructure impacts the behavior of fast and slow traders, the incentive for liquidity provision and liquidity demand, and the competition between exchanges for gaining order flow.

Article I examines a strategic solution to the concern that fast arbitrageurs make liquidity provision more costly by picking off quotes before market makers have time to revise them. The solution in question was to prohibit proprietary traders from engaging in liquidity taking, which prevents fast arbitrageurs from sniping market makers’ stale quotes. The results reveal that the trading ban mitigated adverse selection costs and narrowed the bid-ask spread. Market makers experienced higher profits and quoted higher volumes at better prices. The ban successfully eliminated over half of cross-exchange toxic arbitrage trades.

Article II evaluates the market quality effects of market fragmentation. The study leverages a quasi-natural experiment, which occurred when the Swiss stock markets suddenly transitioned from fragmentation to centralization in July 2019, following the breakdown of EU-Switzerland equivalence rules. Because this event was unrelated to technological developments, and did not disrupt trading, it establishes a firm ground for identifying the effect of fragmentation. The key finding is that greater market fragmentation improves market liquidity, as captured by bid-ask spreads and depth, while it does not impact market efficiency. These results align with theoretical predictions stating that market fragmentation improves liquidity through quote competition across exchanges.

Article III studies the role of restrictions on the minimum tick size and the minimum lot size for determining transaction costs at the futures market. The arrangement of minimum tick and lot sizes by regulators constrains trading at discrete prices and quantities. The study demonstrates, both theoretically and empirically, a trade-off between the restrictions of discrete price and discrete quantity. Given this tradeoff, a futures exchange can minimize futures transaction costs by choosing the optimal futures price. That is, when the futures price is high, it is also relatively more continuous, and the futures quantity is relatively more discrete, compared to the case when the futures price is low. In other words, when the futures price is high rather than low, the lot size restriction causes relatively more friction than the tick size restriction and vice versa. The empirical results strongly support the model.

 

Ort, förlag, år, upplaga, sidor
Stockholm: Stockholm Business School, Stockholm University , 2024. , s. 12
Nyckelord [en]
Market microstructure, latency arbitrage, fragmentation, tick size, lot size, liquidity, adverse selection, market efficiency
Nationell ämneskategori
Företagsekonomi
Forskningsämne
företagsekonomi
Identifikatorer
URN: urn:nbn:se:su:diva-225463ISBN: 978-91-8014-641-8 (tryckt)ISBN: 978-91-8014-642-5 (digital)OAI: oai:DiVA.org:su-225463DiVA, id: diva2:1829398
Disputation
2024-03-04, Lecture Room 19 (Lärosal 19), 2nd floor, House 2, Campus Albano, Albanovägen 18, Stockholm, 13:00 (Engelska)
Opponent
Handledare
Tillgänglig från: 2024-02-08 Skapad: 2024-01-18 Senast uppdaterad: 2024-02-01Bibliografiskt granskad
Delarbeten
1. Latency Arbitrage and Market Liquidity
Öppna denna publikation i ny flik eller fönster >>Latency Arbitrage and Market Liquidity
(Engelska)Manuskript (preprint) (Övrigt vetenskapligt)
Abstract [en]

There is an increasing concern that fast arbitrageurs cause market making more expensive by picking off quotes before the liquidity provider can revise them. This paper shows that restricting aggressive proprietary trading improves adverse selection and liquidity. Specifically, by restricting aggressive proprietary trading, adverse selection costs measured by permanent price movement declined by 21%, liquidity measured by bid-ask spread declined by 11%, and liquidity providers earned higher realized spreads and quoted higher volumes at better prices. In addition, this paper shows that restricted cross-exchange latency arbitrage eliminated more than half of all toxic arbitrage trades. Market makers can benefit from a lower likelihood of being sniped when public information arrives and therefore are subject to lower adverse selection costs. These findings suggest that restricting latency arbitrage improves liquidity by reducing toxic arbitrage.

Nyckelord
Adverse selection; latency arbitrage; toxic arbitrage; passive liquidity protection.
Nationell ämneskategori
Företagsekonomi
Forskningsämne
företagsekonomi
Identifikatorer
urn:nbn:se:su:diva-225369 (URN)
Tillgänglig från: 2024-01-16 Skapad: 2024-01-16 Senast uppdaterad: 2024-02-26Bibliografiskt granskad
2. Market Fragmentation, Liquidity, and Efficiency
Öppna denna publikation i ny flik eller fönster >>Market Fragmentation, Liquidity, and Efficiency
(Engelska)Manuskript (preprint) (Övrigt vetenskapligt)
Abstract [en]

This paper uses a unique quasi-natural experiment to study the market quality effects of market fragmentation across stock exchanges. In July 2019, following the breakdown of EU-Swiss equivalence rules, the Swiss stock markets transitioned from being fragmented to being centralized. As the event was non-gradual (fragmentation went from 31% to zero overnight), widely anticipated, and unrelated to technological developments, strong identification was possible. The main result is that greater market fragmentation leads to greater market tightness and depth without affecting market efficiency. The results confirm theoretical predictions that market fragmentation boosts liquidity through quote competition across exchanges.

Nyckelord
Market microstructure, fragmentation, liquidity, market efficiency
Nationell ämneskategori
Företagsekonomi
Forskningsämne
företagsekonomi
Identifikatorer
urn:nbn:se:su:diva-225419 (URN)
Tillgänglig från: 2024-01-16 Skapad: 2024-01-16 Senast uppdaterad: 2024-02-26Bibliografiskt granskad
3. Tick Size, Lot Size, and Liquidity in Futures Trading
Öppna denna publikation i ny flik eller fönster >>Tick Size, Lot Size, and Liquidity in Futures Trading
(Engelska)Manuskript (preprint) (Övrigt vetenskapligt)
Abstract [en]

Futures are standardized and heavily regulated contracts, and these features make futures trading possible on liquid secondary markets. However, regulations constrain futures trading at discrete prices and quantities by imposing a minimum tick size and a minimum lot size. We show, theoretically and empirically, that the tick size and the lot size are important for futures trading costs. In our model, we express the bid-ask spread of futures, given lot size and tick size restrictions, as a function of futures volatility and trading activity by informed and uninformed traders. Our empirical results support the theoretical model.

Nyckelord
Futures, tick size, lot size, transactions costs
Nationell ämneskategori
Företagsekonomi
Forskningsämne
företagsekonomi
Identifikatorer
urn:nbn:se:su:diva-225461 (URN)
Tillgänglig från: 2024-01-16 Skapad: 2024-01-16 Senast uppdaterad: 2024-02-26Bibliografiskt granskad

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