Competition For Order Flow, Market Quality, And Price Discovery In The Nasdaq 100 Index Tracking Stock

We investigate competition for order flow, market quality, and price discovery in the Nasdaq 100 Index Tracking Stock (QQQ). The QQQ, an AMEX‐listed, exchange‐traded fund, is the most actively traded security in the U.S. equities market. On July 31, 2001, the NYSE began trading the QQQ, marking the first time it traded securities of companies it does not list. The greatest volume of trading takes place on electronic communication networks (ECNs), following by trading on the AMEX and the NYSE. Most of the block trades are executed on the AMEX, where the bid‐ask spreads are narrower. We find that ECNs contribute the most to the price‐discovery process. The spreads on all trading platforms have decreased and market quality and price discovery have improved since QQQ shares have traded on the NYSE.     

Transaction costs in an illiquid order‐driven market

Transaction costs in many international equity markets are much larger than those in the USA. This raises questions such as what trade size these reported trading costs relate to and whether investors can reduce trading costs by timing their trades. We show, using data from the order‐driven New Zealand market, that transaction costs are frequently lower for larger trades, particularly in small stocks, and investors are able to reduce costs by timing their transactions. While investors who require immediate execution incur transaction costs that are much higher than reported average costs, patient investors can trade at much better rates.     

Secondary Trading Costs in the Municipal Bond Market

Using new econometric methods, we separately estimate average transaction costs for over 167,000 bonds from a 1‐year sample of all U.S. municipal bond trades. Municipal bond transaction costs decrease with trade size and do not depend significantly on trade frequency. Also, municipal bond trades are substantially more expensive than similar‐sized equity trades. We attribute these results to the lack of bond market price transparency. Additional cross‐sectional analyses show that bond trading costs increase with credit risk, instrument complexity, time to maturity, and time since issuance. Investors, and perhaps ultimately issuers, might benefit if issuers issued simpler bonds.     

Price Discovery in the Treasury‐Bill When‐Issued Market

When‐issued (i.e., forward) trading in T‐bills yet to be auctioned provides a unique environment for examining price discovery. Because T‐bills are auctioned in a sealed‐bid process, when‐issued traders cannot observe the spot market price. Yet the forward price must ultimately converge on the auction outcome price. Our results indicate that traders in the when‐issued market “discover” the ultimate auction price. Little evidence is found that standard order flow variables contribute to price discovery. Instead, the ability to observe a few trades with relatively small volume in the when‐issued market is sufficient to discover the auction price resulting from the sealed‐bid process.     

Nasdaq and The Chicago Stock Exchange: An Analysis of Multiple Market Trading

We analyze a set of 97 NASD-listed securities that trade on both the Nasdaq and Chicago Stock Exchange (CHX) to determine if trading costs and price improvement differ between the two markets. We find that order execution costs, which we define by the traded spread and the signed effective half-spread, are significantly lower on the CHX. This difference is consistent over trade types and for trades of at least 1,000 shares. Also, we find that trades occurring on the CHX receive more price improvement than do those occurring on Nasdaq.     

The Market Evaluation of Information in Directors' Trades

The purpose of this paper is to examine the propensity, characteristics and performance of directors' trades. Consistent with prior research we show that on average, directors outperform the market. However, we also find that there exist a large number of trades which do not share these abnormal share price returns and consequently have little information content. This has important consequences for market participants who use director trading activity as a signal for their own trading strategies. Using different measures of directors' trades based on trade characteristics, we report that purchases by directors are more informative than sales. In addition, the number of directors trading within a twenty day window and the percentage of the directors' holding that is being traded are both important factors in the abnormal share price performance following the trade.     

Market transparency,liquidity externalities,and institutional trading costs in corporate bonds

We develop a simple model of the effect of public transaction reporting on trade execution costs and test it using a sample of institutional trades in corporate bonds, before and after initiation of the TRACE reporting system. Trade execution costs fell approximately 50% for bonds eligible for TRACE transaction reporting, and 20% for bonds not eligible for TRACE reporting, suggesting the presence of a “liquidity externality.” The key results are robust to changes in variables, such as interest rate volatility and trading activity that might also affect execution costs. Market shares and the cost advantage to large dealers decreased post-TRACE. These results indicate that market design can have first-order effects, even for sophisticated institutional customers.     

Mutual Fund Stock‐Picking Skill: New Evidence from Valuation‐ versus Liquidity‐Motivated Trading

We propose a novel Trade Motivation Matrix that allows differentiating funds’ valuation‐motivated (VM) and liquidity‐motivated (LM) trades on single trade level. It thus enables analyses of stock‐picking skill on three levels: trade, stock, and fund. On trade level, we find significant outperformance of VM buys and significant underperformance of VM sells, indicating manager stock‐picking skills, especially during illiquid market periods. VM trades outperform LM trades, confirming negative performance effects due to flow risk, especially when market liquidity is low. On stock level, collective VM buying explains high future stock returns while collective VM selling is related to future losses, indicating wisdom of the crowd. On fund level, higher trading discretion, measured by a higher degree of VM trading, is observed for smaller, older funds holding higher cash buffers. Finally, higher trading discretion is related to higher future fund alpha, especially during illiquid times.     

EX‐DIVIDEND DAY PRICE BEHAVIOR OF EXCHANGE‐TRADED FUNDS

We document that for exchange‐traded funds (ETFs), the price falls on average by the dividend amounts on the ex‐dividend day, and there are significantly positive abnormal volumes. This is because trading in ETFs entails lower transaction costs and lower risk than trading in equity closed‐end funds (CEFs) and individual stocks. Similar results are also found for equity CEFs. However, regression analyses indicate that transaction costs and risk are indeed negligible for ETFs but not for equity CEFs and that risk remains important for a sample of stocks matched based on transaction costs. Overall, the results support the short‐term traders hypothesis.     

Providing liquidity in an illiquid market: Dealer behavior in US corporate bonds

We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers’ holding periods do not decline with a bond's prior trading activity and in fact are lowest for some of the least active bonds. As a result, cross-sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.     

THE CHOICE OF TRADING VENUE AND RELATIVE PRICE IMPACT OF INSTITUTIONAL TRADING: ADRs VERSUS THE UNDERLYING SECURITIES IN THEIR LOCAL MARKETS

We address two important themes associated with institutions’ trading in foreign markets: (1) the choice of trading venues (between a company's listing in its home market and that in the United States as an American Depositary Receipt [ADR]) and (2) the comparison of trading costs across the two venues. We identify institutional trading in both venues using proprietary institutional trading data. Overall, our research underscores the intuition that the choice of institutional trading in a stock's local market or as an ADR is a complex process that embodies variables that measure the relative adverse selection and liquidity at order, stock, and country levels. Institutions route a higher percentage of trades to more liquid markets, and these trades are associated with higher cumulative abnormal returns. We also find that institutional trading costs are generally lower for trading cross‐listed stocks on home exchanges even after controlling for selection bias.     

Who benefits in a crisis? Evidence from hedge fund stock and option holdings

We use a unique data set of hedge fund long equity and equity option positions to investigate a significant lockup-related premium earned during the tech bubble (1999–2001) and financial crisis (2007–2009). Net fund flows are significantly greater among lockup funds during crisis and noncrisis periods. Managers of hedge funds with locked-up capital trade opportunistically against flow-motivated trades of non-lockup managers, consistent with a hypothesis of rent extraction in providing crisis era liquidity. The success of this opportunistic trading is concentrated during periods of high borrowing costs, in less liquid stock markets, and is enhanced by hedging in the equity option market.     

Information trading by corporate insiders based on accounting accruals: forecasting economic performance

In this paper, we test whether directors’ (corporate insiders) trading in Australia, based on accounting accruals, provides incremental information in forecasting a firm's economic performance. We determine that directors’ trading on negative accruals in larger firms has greater forecasting content and is associated with 1‐year‐ahead bull market phases. Moreover, arbitrage portfolios set up to mimic insider trading can earn 1‐year‐ahead excess size‐adjusted arbitrage returns of up to 12.2 per cent. Results are consistent with directors hiding their trades in liquid well‐traded firms and in providing incremental information above that supplied by a continuous information regime.     

Competition among Trading Venues: Information and Trading on Electronic Communications Networks

This paper explores the competition between two trading venues, Electronic Communication Networks (ECNs) and Nasdaq market makers. ECNs offer the advantages of anonymity and speed of execution, which attract informed traders. Thus, trades are more likely to occur on ECNs when information asymmetry is greater and when trading volume and stock‐return volatility are high. ECN trades have greater permanent price impacts and more private information is revealed through ECN trades than though market‐maker trades. However, ECN trades have higher ex ante trading costs because market makers can preference or internalize the less informed trades and offer them better executions.     

Market Structure and Transaction Costs of Index CDSs

Despite regulatory efforts to promote all-to-all trading, the post–Dodd-Frank index credit default swap market remains two-tiered. Transaction costs are higher for dealer-to-client than interdealer trades, but the difference is explained by the higher, largely permanent, price impact of client trades. Most interdealer trades are liquidity motivated and executed via low-cost, low-immediacy trading protocols. Dealer-to-client trades are nonanonymous; they almost always improve upon contemporaneous executable interdealer quotes, and dealers appear to price discriminate based on the perceived price impact of trades. Our results suggest that the market structure is a consequence of the characteristics of client trades: relatively infrequent, large, and differentially informed.     

Informed Trading in Corporate Bonds Prior to Earnings Announcements

This paper examines the information content of corporate bond trading prior to earnings announcements using data from both NAIC and TRACE. We find that the direction of pre‐announcement bond trading is closely related to earnings surprises. This link is most evident prior to negative news and in high‐yield bonds. Further, abnormal bond trading during the pre‐announcement period can help predict both earnings surprises and post‐announcement bond returns. Such predictive ability of bond trading largely originates from institutional‐sized trades and is concentrated in the issuer's most actively traded bond. Finally, even after accounting for transactions costs, informed bond trading can generate significant net profits, especially prior to the release of bad news.     

IPO Trading without Market Makers or Underwriter Price Support

We investigate the trading behavior and liquidity supply of Chinese initial public offerings (IPOs) that trade in an order‐driven market system with pure limit order books where no market makers or price support is allowed. We find large trades and quoted depths dominate the first day of trading, but this pattern quickly reverses as small trades and quoted depths are more prevalent on subsequent trading days. Quoted depths are positively related to the number of shares offered in the IPO and trade size, but are negatively related to underpricing. Trade size and transaction immediacy are positively related, and large and positive (negative) order imbalance is associated with more aggressive buys (sells). Finally, long‐run performance is not related to initial order imbalance. Overall, our results suggest that despite underwriters not participating in the IPO aftermarket, liquidity provision evolves very quickly and price discovery is immediately reflected in prices.     

Price Movers on the Stock Exchange of Thailand: Evidence from a Fully Automated Order‐Driven Market

This study examines which trade sizes move stock prices on the Stock Exchange of Thailand (SET), a pure limit order market, over two distinct market conditions of bull and bear. Using intraday data, the study finds that large‐sized trades (i.e., those larger than the 75th percentile) account for a disproportionately large impact on changes in traded and quoted prices. The finding remains even after it has been subjected to a battery of robustness checks. In contrast, the results of studies conducted in the United States show that informed traders employ trade sizes falling between the 40th and 95th percentiles ( Barclay and Warner, 1993 ; Chakravarty, 2001 ). Our results support the hypothesis that informed traders in a pure limit order market, such as the SET, where there are no market makers, also use larger‐size trades than those employed by informed traders in the United States.     

INFORMATION AND NOISE IN FINANCIAL MARKETS: EVIDENCE FROM THE E‐MINI INDEX FUTURES

I examine the informational contributions and effects on transitory volatility of trades initiated by different types of traders in three actively traded index futures markets. The results show that trades initiated by exchange member firms account for more than 60% of price discovery during the trading day. These institutional trades appear to be more informative than trades of individual exchange members or off‐exchange traders. I also find that off‐exchange traders introduce more noise into the prices than do exchange members. My findings provide new evidence on the role of different types of traders in the price formation process.     

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.