Emerging from Bankruptcy with When‐Issued Trading

We examine the set of firms that emerged from Chapter 11 bankruptcy and traded on a when‐issued basis before their official return to the regular way in NASDAQ, Amex, or NYSE. We find that this when‐issued market is liquid and price efficient. The when‐issued closing price is a good indicator of the first closing price in the regular way market. Emerging firms that have when‐issued trading experience lower regular way volatility and smaller relative spreads than those without when‐issued trading. Our probit regressions show that firm size is an important determinant of the adoption of when‐issued trading.     

RECENT GROWTH IN NASDAQ TRADING VOLUME AND ITS RELATION TO MARKET VOLATILITY

We document a significant increase in Nasdaq trading volume relative to New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) trading volumes. Although recent increases in the number of shares traded are reported in the financial press, we also find it present in the percentage of dollar values traded. We then examine correlations between trading volume and several measures of market volatility. Nasdaq volume appears to be more closely correlated with residual variance, while NYSE and AMEX volumes are more closely correlated with overall market variance. We conclude that the type and quantity of information driving trading are different on Nasdaq than on the two exchanges, and that the relative growth in Nasdaq volume cannot be attributed solely to differences in the methods of counting volume in the two market environments.     

Regulation NMS and Market Quality

We show that both the quoted and effective spreads increased, the quoted depth decreased, and the market quality index decreased after the implementation of Regulation National Market System (NMS) (Reg NMS). We also find an increase in the price impact of trades and the dispersion of the pricing error after Reg NMS. The order execution speed is slower, the order fill rate is lower, and the order cancellation rate is higher for most trades after Reg NMS. Hence, contrary to the Securities and Exchange Commission's belief, Reg NMS has proven to be detrimental to most traders. NASDAQ provided faster and more reliable executions than the NYSE/AMEX, and NASDAQ gained market shares from the NYSE/AMEX and other trading venues after Reg NMS.     

Can Island Provide Liquidity and Price Discovery in the Dark?

On September 23, 2002, facing a regulatory mandate issued by the Securities and Exchange Commission, Island teminated the position of the Nasdaq 100 Index Tracking Stock (QQQ) on its book. While the market volume remained almost the same, Island's market share in the QQQ fell significantly. However, Island still dominates other trading centers in the price discovery process and volatility spillovers. The spreads on most trading centers became narrower after Island removed its quotes from the public view. The overall results suggest that the decrease in market transparency does not compromise market liquidity. Informed traders who provide price discovery in the QQQ are willing to sacrifice potential price improvements for the fast speed and reliable execution that Island offers, and are able to trade in the absence of displayed quotes.     

Why effective spreads on NASDAQ were higher than on the New York stock exchange in the 1990s

Two hypotheses have been advanced to explain why spreads on NASDAQ were substantially higher than those on the NYSE in the 1990s: “collusion” and “preferencing and payment for order flow.” We present data on all actively traded stocks in these markets of relative effective spreads (RES), aggregated monthly over 1987–1999 and advance a third hypothesis: NASDAQ “SOES-day-trading.” We estimate NASDAQ and NYSE informed-trade losses and gains to market makers and other liquidity providers on six trade sizes, and find that losses on trades we ascribe to SOES day traders were substantially greater than those on other trades, offset somewhat by gains from small-trade-size investors. NASDAQ market makers' response to these losses and additional operations costs incurred to reduce the losses resulted in greater RES and increased trading within the best quotes, predominantly on larger trade sizes. The data are consistent with the “SOES-day-trading” hypotheses, but not with the other two. Furthermore, the mandatory SOES “experiment” provides insights into the negative effects of automated trading systems (such as ECNs, which now dominate NASDAQ) when their design does not adequately consider opportunistic traders.     

UNLISTED TRADING PRIVILEGES,LIQUIDITY, AND STOCK RETURNS

In this study we examine the effect of dual trading through unlisted trading privileges (UTPs) on liquidity and stock returns. Stocks with UTPs trade in a different market structure than stocks listed and traded only on the AMEX and NYSE. Differences in market structure may affect stock returns through liquidity services provided by the competing markets. The sample comprises 852 AMEX and NYSE firms that began unlisted trading on the Philadelphia, Pacific, Midwest, or Cincinnati exchanges between 1984 and 1988. The results show significantly positive abnormal returns around the SEC's announcement of a regional exchange's filing for UTPs. The results also suggest that increased competition improves trading liquidity. Only stocks with low liquidity before UTPs announcements experience significantly improved liquidity and positive stock returns.     

Price discovery and the international flow of information

We document that the opening volatility of American depositary receipts (ADRs) is lower when the trading of the underlying asset overlaps trading of the ADR on the New York Stock Exchange (NYSE). This lower volatility is consistent with the notion that price discovery on the NYSE is enhanced by concurrent trading in the underlying market. We also find that ADR volatility does not change when the underlying market closes, indicating that there is no significant change in the flow of public and private information at that time. This finding suggests that the NYSE becomes the dominant market during periods when both ADRs and their underlying assets are traded.     

Liquidity,Information, and Infrequently Traded Stocks

This article investigates whether differences in information-based trading can explain observed differences in spreads for active and infrequently traded stocks. Using a new empirical technique, we estimate the risk of information-based trading for a sample of New York Stock Exchange (NYSE) listed stocks. We use the information in trade data to determine how frequently new information occurs, the composition of trading when it does, and the depth of the market for different volume-decile stocks. Our most important empirical result is that the probability of information-based trading is lower for high volume stocks. Using regressions, we provide evidence of the economic importance of information-based trading on spreads.     

MARKET STRUCTURE AND REPORTED TRADING VOLUME: NASDAQ VERSUS THE NYSE

Trading volume for common stocks is of interest to financial economists, investors, and securities lawyers. NASDAQ is a dealer market where trades with dealers are included in reported trading volume. This procedure does not accurately measure the trading volume by public buyers and sellers. Trading volume reported on the NYSE, which is primarily an auction market, provides a much closer measure of trades by public investors. We examine a sample of firms whose stock traded on the NASDAQ/NMS and subsequently on the NYSE. When trading switches to the NYSE, the firms' trading volume drops to about 50 percent of the volume previously reported on NASDAQ. A control group of firms that switched from the AMEX to the NYSE shows a small, but statistically insignificant, increase in trading volume.     

The Post-Reform Bid-Ask Spread Disparity between Nasdaq and the NYSE

We report further evidence of the difference in execution costs between Nasdaq and the NYSE before and after the 1997 market reforms. We find that informed trading costs are consistently higher on Nasdaq both before and after the reforms. In the pre‐reform period the Nasdaq‐NYSE disparity in bid‐ask spreads cannot be completely attributed to the difference in informed trading costs. However, in the post‐reform period the spread difference between these two markets becomes insignificant with the effect of informed trading costs controlled. Our findings are consistent with the contention that the reforms have largely reduced noninformation trading costs and dealers' rents.     

Volatility increases Subsequent to NYSE and AMEX Stock Splits

The post-split increase in daily returns volatility is less for AMEX stocks than for NYSE stocks. The exchange trading location is a significant factor in explaining the volatility shift even after stock price and firm size are considered. Furthermore, when measured on a weekly basis, there is no increase in AMEX stocks' returns volatility. These results suggest that measurement errors created by bid-ask spreads and the 1/8 effect, and also one or more of the elements that make the NYSE different from the AMEX, explain why the estimated volatility of daily stock returns increases after the ex split date.     

Short‐ and Long‐Term Effects of Multimarket Trading

We analyze short‐ and long‐term effects of multimarket trading by examining the entries of multiple markets into transacting three ETFs, DIA, QQQ, and SPY. We find that large‐scale entries improve overall market quality, while small‐scale entries have ambiguous effects. Our results show that the competition effect dominates the fragmentation effect over a long horizon and that market fragmentation leads to a decline in trading costs. Further, we find that the order handling rules help mitigate the fragmentation effect and facilitate the competition effect. We do not find that multimarket trading harms price efficiency or increases price volatility.     

On the Stability of the Cross‐Section of Expected Stock Returns in the Cross‐Section: Understanding the Curious Role of Share Turnover

In this paper, we shed further light on cross‐sectional predictors of stock return performance. Specifically, we explore whether the cross‐section of expected stock returns is robust within stock groups sorted by past monthly return. We find that the book/market and momentum effects are remarkably robust to sorting on past returns. However, share turnover is negatively related to future returns for stocks with abnormally low stock price performance in the recent past, but postively related to returns for well‐performing stocks. This casts doubt on the use of turnover as a liquidity proxy, but is consistent with turnover being a proxy for momentum trading which pushes prices in the direction of past price movements. Our results are robust to both NYSE/AMEX and Nasdaq stocks, and also robust to stratifying the sample by time period.     

Speed of convergence to market efficiency: The role of ECNs

Chordia, Roll and Subrahmanyam (2005, CRS) estimate the speed of convergence to market efficiency based on short-horizon return predictability of the 150 largest NYSE firms. We extend CRS to a broad panel of NYSE stocks and are the first to examine the relation between electronic communication networks (ECNs) and the corresponding informational efficiency of prices. Overall, we confirm CRS's result that price adjustments to new information occur on average within 5–15 min for large NYSE stocks. We further show that it takes about 20 min longer for smaller firms to incorporate information into prices. Most importantly, we demonstrate that the speed of convergence to market efficiency is significantly related to the type of trading platform where orders are executed, even after controlling for relative order flows, trading costs, volatility, informational effects, trading conditions, market quality, institutional trading activity, and other firm-specific characteristics. Our findings provide direct answers and insights to issues raised in a recent SEC concept release document.     

The Impact of the Reduction in Tick Increments in Major U.S. Markets on Spreads,Depth, and Volatility

This study presents an analysis of the impact of the introduction of quotes in sixteenths of a dollar on the AMEX, Nasdaq, and NYSE in mid-1997 on select market characteristics such as spreads, effective spreads, quoted depth, and volume. The findings of the study document reductions in the bid-ask spread, effective spread, and a statistically significant increase in the number of quotes. Interestingly, we find that liquidity, as measured by the total depth at the bid and ask, declines significantly on the AMEX and NYSE, but increases on the Nasdaq. Trading volume increases on the NYSE, but remains unchanged for the AMEX and Nasdaq. We also find that the proportion of even-increment quotes is a relevant factor affecting percentage spreads for Nasdaq both before and after and for the NYSE only after the change in quoting increments.     

Testing for micro-structure effects of international dual listings using intraday data

This paper examines the impact on the liquidity of NYSE/AMEX listed stocks when they were subsequently listed on the London or the Tokyo Stock Exchanges. It can be argued that the increased competition from foreign market makers will reduce the monopoly rents that specialists can earn, thereby improving their quotes. We find, however, that spreads do not decrease following a dual listing, though the depth of the quotes increases as predicted. The apparent increase in depth disappears once we account for changes in price, volume and return variance. We also find that the level of informed trading increases, which increases the cost to the specialist of providing liquidity, and explains why spreads do not decline in spite of increased competition. Consistent with an increase in informed trading, we also document an increase in trading activity.     

The Intraday Relation between NYSE and CBOE Prices

I extend the literature regarding price discovery across stock and option markets through an empirical model that allows information to flow through an error‐correction term and volatility. NYSE prices tend to lead CBOE prices by at least thirty minutes over the entire six‐year sample period. In addition, informed trading in the options market is revealed more strongly through persistence in volatility and the spillover of volatility to the stock market than it is through returns.     

LIQUIDITY AND ASSET PRICING UNDER THE THREE‐MOMENT CAPM PARADIGM

We examine whether the use of the three‐moment capital asset pricing model can account for liquidity risk. We also make a comparative analysis of a four‐factor model based on Fama–French and Pástor–Stambaugh factors versus a model based solely on stock characteristics. Our findings suggest that neither of the models captures the liquidity premium nor do stock characteristics serve as proxies for liquidity. We also find that sensitivities of stock return to fluctuations in market liquidity do not subsume the effect of characteristic liquidity. Furthermore, our empirical findings are robust to differences in market microstructure or trading protocols between NYSE/AMEX and NASDAQ.     

The Quality of ECN and Nasdaq Market Maker Quotes

This paper compares the quality of quotes submitted by electronic communication networks (ECNs) and by traditional market makers to the Nasdaq quote montage. An analysis of the most active Nasdaq stocks shows that ECNs not only post informative quotes, but also, compared to market makers, ECNs post quotes rapidly and are more often at the inside. Additionally, ECN quoted spreads are smaller than dealer quoted spreads. The evidence suggests that the proliferation of alternative trading venues, such as ECNs, may promote quote quality rather than fragmenting markets. Moreover, the results suggest that a more open book contributes to quote quality.     

Preferenced Trading,Quote Competition,and Market Quality: Evidence from Decimalization on the NYSE

We examine the impact of decimalization on preferenced trading in NYSE‐listed stocks and show a significant decline in preferenced trading around decimalization. For the largest NYSE stocks, the total decline is nearly 22%. We also find a negative correlation between the changes in preferenced trading and the changes in quote competition intensity, and a positive correlation between the changes in preferenced trading and the changes in spreads. Consistent with the cream skimming hypothesis, we find that abnormal changes in information asymmetry cost for NYSE trades are positively correlated with the changes in preferenced trading.