Ellul, Andrew
(2001)
Trading behaviour, price discovery and volatility in competing market microstructures.
PhD thesis, London School of Economics and Political Science.
Abstract
The first chapter investigates the price and volatility impacts produced by block trades in an inter-market environment with different microstructures. A sample of European cross-traded securities is employed to investigate whether large trades executed on the foreign market (London Stock Exchange's SEAQ-I market) produce any impacts on the securities' home markets and analyse whether different market microstructures matter. The price impact in the home markets is detected before the large trade is executed on SEAQ-I and proceeds in a protracted fashion, implying that substantial pre- and post-positioning is undertaken by London market makers through the home markets. The new equilibrium price on the home market is reached before the trade information is published on SEAQ-I. Large trades are also found to cause higher price volatility in auction trading systems than in a hybrid market microstructure. The second and third chapters analyse the formation of quoted and effective spreads and their components in three different market microstructures. The results show that quoted and effective spreads generated by a hybrid system (Deutsche Borse's IBIS system) are lower than those generated by both the pure auction system (Paris Bourse's CAC system) and the dealership system (London Stock Exchange SEAQ market). Traders on a hybrid mechanism face the lowest costs and this result holds even when we control for (a) the level of market concentration in liquidity provision, and (b) company-specific news. However, the adverse selection component of the spread is significantly higher in an auction trading system compared to both the dealership and the hybrid trading system. This fifth chapter investigates (a) whether, in a hybrid trading mechanism, voluntary market makers provide a higher level of price stabilisation than limit order traders even if they do not have any obligation to keep orderly markets, (b) the strategic interactions between the limit order book and market makers, and (c) the behaviour of the order flow at times of price uncertainty. We analyse these issues using high frequency data from the London Stock Exchange which has adopted a hybrid market microstructure. We find that prices on the dealership system track the security's true value more efficiently. The dealership system can transact higher volumes with lower price volatility. This evidence suggests that market makers provide price stabilisation, even if they have no binding obligation to do so, thus improving the market's quality. In terms of trading behaviour, we find that in a hybrid trading mechanism, traders are not encouraged to provide liquidity on the order book through limit orders as price uncertainty increases. Instead orders migrate to the dealership system for execution.
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