THE IMPACT OF MARKET MAKER CONCENTRATION ON ADVERSE‐SELECTION COSTS FOR NASDAQ STOCKS

We examine the impact of market maker concentration on adverse‐selection costs for NASDAQ stocks and find that more market makers results in lower costs. Furthermore, this reduction in adverse selection exceeds the overall reduction in spreads that is attributable to market maker competition. We hypothesize that order flow internalization is increasing in market makers and allows for greater information production, and is an explanation for our findings. Our results provide an explanation for the puzzle documented by previous work that finds that adverse‐selection costs for NASDAQ tend to be lower than for the New York Stock Exchange, whereas spreads tend to be higher.     

THE EFFECTS OF DECIMALIZATION ON RETURN VOLATILITY COMPONENTS,SERIAL CORRELATION,AND TRADING COSTS

We examine the composition of return volatility, serial correlation, and trading costs before and after decimalization on the New York Stock Exchange. We decompose the variance of price changes into components associated with public news, rounding errors, and market‐making frictions. We find that when stocks move from a fractional to a decimal trading system, the variance components due to market‐making frictions and rounding errors decline significantly, whereas the component due to public news remains unchanged. The serial correlation of price changes weakens substantially after decimalization. The uninformed component of bid‐ask spreads decreases significantly whereas the informed component has no significant change.     

LIQUIDITY AND QUOTE CLUSTERING IN A MARKET WITH MULTIPLE TICK SIZES

We analyze market liquidity (i.e., spreads and depths) and quote clustering using data from the Kuala Lumpur Stock Exchange (KLSE), where the tick size increases with share price in a stepwise fashion. We find that stocks that are subject to larger mandatory tick sizes have wider spreads and less quote clustering. We also find that liquidity providers on the KLSE do not always quote larger depths for stocks with larger tick sizes. Overall, our results suggest that larger tick sizes for higher priced stocks are detrimental to market liquidity, although the adverse effect of larger tick sizes is mitigated by lower negotiation costs (i.e., less quote clustering).     

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 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.     

FURTHER EVIDENCE ON INSIDER TRADING AND THE MERITS OF SECURITIES CLASS ACTIONS

To provide further evidence on the merits of securities class actions, we examine insider transactions immediately before and during the class period, using a larger and newer data set. We show that insiders reduce their stock sales by an abnormal amount immediately before the class period. Alternative measures of insider transactions and analysis of data before the enactment of the Private Securities Litigation Reform Act of 1995 provide consistent results. These new findings indicate that class actions, on average, have merit. Our data also reestablish a previous empirical result that there is no abnormal selling during the class period.     

THE EFFECT OF CROSS‐LISTING ON TRADING VOLUME: REDUCING SEGMENTATION VERSUS SIGNALING INVESTOR PROTECTION

We examine the relation between cross‐listing on the U.S. and UK regulated and unregulated exchanges and trading volume for a sample of 500 foreign firms from 34 countries. We find that the increase in trading volume is a function of both reducing segmentation and signaling investor protection. In addition, we find that home market trading volume, firm size, firm returns, and analyst forecast accuracy are the major determinants of a firm's trading volume. We also show that U.S. and UK investors trade foreign securities that originate from low‐investor‐protection countries more than they trade those from high‐investor‐protection countries, which is consistent with the bonding hypothesis.     

THE EFFECTS OF INSIDER TRADING RESTRICTIONS: EVIDENCE FROM HISTORICAL DIVIDEND INITIATIONS AND OMISSIONS

We investigate whether insider trading restrictions had their intended effects during the 1960s and 1970s. We examine insider trading and stock market behavior before dividend initiations and omissions announced between 1935 and 1974. Contrary to existing research and commentary, we show that restrictions had meaningful effects. During the 1960s and 1970s, insiders sold less frequently before dividend omissions, and the average profitability of insider trades declined. In addition, the positive (negative) stock price runup before dividend initiations (omissions) decreased after 1961. The results provide some vindication for the Securities and Exchange Commission's adjudicative approach toward insider trading regulation.     

PRICE AND QUANTITY QUOTES ON NASDAQ: A STUDY OF DEALER QUOTATION BEHAVIOR

We show that the majority of quotes posted by NASDAQ dealers are noncompetitive and only 19.5% (18.4%) of bid (ask) quotes are at the inside. The percentage of dealer quotes that are at the inside is higher for stocks with wider spreads, fewer market makers, and more frequent trading, and lower for stocks with larger trade sizes and higher return volatility. These results support our conjecture that dealers have greater incentives to be at the inside for stocks with larger market‐making revenues and smaller costs. Dealers post large depths when their quotes are at the inside and frequently quote the minimum required depth when they are not at the inside. The latter quotation behavior leads to the negative intertemporal correlation between dealer spread and depth.     

SLIPPAGE AND THE CHOICE OF MARKET OR LIMIT ORDERS IN FUTURES TRADING

Retail futures traders face uncertainty regarding the price they will obtain when trading. This price surprise, known as slippage, can be substantial. Using unique data from an introducing brokerage for Chicago Board of Trade (CBOT) wheat, corn, and soybean futures contracts, we quantify time-to-clear and the magnitude of slippage. We then identify factors that affect these trade quality measures. Finally, we analyze individual trader choice between market and limit orders and find that the likelihood of placing limit orders, where regulations protect traders from slippage, is greater when order and market characteristic indicate that adverse slippage is likely.     

THE ECONOMIC GAINS OF TRADING STOCKS AROUND HOLIDAYS

I assess the economic gains of strategies that account for the effect of holiday calendar effects on the daily returns and volatility of the 30 stocks in the Dow Jones Industrial Average index. The dynamic strategies use forecasts from stochastic volatility models that distinguish between regular trading days and different types of holidays. More important, I assess the economic value of conditioning on holiday effects and find that a risk-averse investor will pay a high performance fee to switch from a dynamic portfolio strategy that does not account for the effect of holidays on daily conditional expected returns and volatility to a strategy that does. This result is robust to reasonable transaction costs.     

TRADING OF NASDAQ STOCKS ON THE CHICAGO STOCK EXCHANGE

We use a linear programming model to form two portfolios with approximately equal levels of attributes such as financial leverage. One portfolio comprises stocks that trade exclusively on NASDAQ and the other, stocks that trade on both the Chicago Stock Exchange (CSE) and NASDAQ (CSE/NASDAQ). We find that spreads are lower for the CSE/NASDAQ portfolio, but so is the percentage of quotes at spreads of $0.125. In fact, the lower spreads observed for the CSE/NASDAQ portfolio arise from fewer quotes with spreads of more than $0.25.     

GLAMOUR VERSUS VALUE: TRADING BEHAVIOR OF INSTITUTIONS AND INDIVIDUAL INVESTORS

We design a new metric to measure the net buying and selling by institutions and individual investors and find that from 1980 to 2004 institutional investors were net buyers of growth stocks and net sellers of value stocks, implying that individual investors were net buyers of value stocks and net sellers of glamour stocks. The institutional preference for glamour and value stocks seems to be related to sell‐side analysts' recommendations and recent favorable stock price performances, especially during the post‐1994 period. Finally, the institutional buying of growth stocks and sale of value stocks was not based on superior information.     

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.     

TRADING COSTS OF NON‐U.S. STOCKS ON THE NEW YORK STOCK EXCHANGE: THE EFFECT OF INSTITUTIONAL OWNERSHIP,ANALYST FOLLOWING,AND MARKET REGULATION

We investigate the differences in market microstructure between U.S. and non‐U.S. stocks cross‐listed on the New York Stock Exchange using a sample of 316 pairs of matched stocks. We find that non‐U.S. stocks have wider spreads and larger adverse‐selection costs than U.S. stocks even after controlling for macro‐level institutional differences. Regression analysis shows that spreads and adverse‐selection costs are negatively correlated with institutional ownership and analyst followings. Thus, the higher spreads and adverse‐selection costs for non‐U.S. stocks can be partly explained by the lower institutional ownership and analyst following of non‐U.S. stocks. In addition, we find that although the spreads and adverse‐selection costs for non‐U.S. stocks are significantly higher before the implementation of Regulation Fair Disclosure (FD), the differences become even greater after Regulation FD, suggesting that Regulation FD has improved the information environment for U.S. stocks.     

THE FUNDAMENTAL DETERMINANTS OF TRADING VOLUME REACTION TO FINANCIAL INFORMATION: EVIDENCE AND IMPLICATIONS FOR EMPIRICAL CAPITAL MARKET RESEARCH

Prior empirical research indicates that trading volume reaction to new information increases with the heterogeneity of investors’ prior beliefs. We examine three potential factors that theoretical models of financial economists show determine trading volume reaction to new information: heterogeneous prior beliefs, differential interpretation, and the consensus effect—the extent to which the information causes their beliefs to converge or diverge. We find that these three factors have a distinct and significant incremental effect on trading volume, thereby suggesting that empirical trading volume models that exclude or fail to control for any of these determinants are misspecified with biased estimated coefficients.     

MACROECONOMIC NEWS,STOCK TURNOVER,AND VOLATILITY CLUSTERING IN DAILY STOCK RETURNS

We study volatility clustering in daily stock returns at both the index and firm levels from 1985 to 2000. We find that the relation between today's index return shock and the next period's volatility decreases when important macroeconomic news is released today and increases with the shock in today's stock market turnover. Collectively, our results suggest that volatility clustering tends to be stronger when there is more uncertainty and disperse beliefs about the market's information signal. Our findings also contribute to a better understanding of the joint dynamics of stock returns and trading volume.     

SECURITY RETURN DISTRIBUTIONS AND MARKET STRUCTURE: EVIDENCE FROM THE NYSE/AMEX AND THE NASDAQ MARKETS

This paper documents significant and persistent deviations from normality in security return distributions for the NYSE, AMEX, and NASDAQ from 1974 to 1988. Controlling for January and size effects, we find that the deviations of security return distributions from normality decline with increasing portfolio size and investment horizon for the NYSE and AMEX, especially for daily returns. Deviations appear to be greater for the NASDAQ than for the two exchanges even for firms of the same size. Ratios of monthly to daily variances are also larger for the NASDAQ. These results suggest that nonparametric or other robust statistical techniques should be used when valuing equity options and other derivatives, especially when examining NASDAQ security returns. They further imply that trading strategies based on market inefficiencies are more likely to succeed on the NASDAQ.     

TRANSACTION COSTS AND DAY-OF-THE-WEEK EFFECTS IN THE OTC/NASDAQ EQUITY MARKET

A potential explanation is examined here for the observed day-of-the-week effect in equity returns—systematic daily patterns in percentage bid-ask spreads. Using OTC/NASDAQ data over 1973–1985, strong return day-of-the-week effects are documented while mean dealer percentage spreads are essentially unchanged over the week. These results provide evidence that systematic percentage spread changes do not contribute to the observed return anomaly.     

DYNAMIC ORDER SUBMISSION AND HERDING BEHAVIOR IN ELECTRONIC TRADING

I analyze the dynamic trading behavior of market participants by developing a bivariate modeling framework for describing the arrival process of buy and sell orders in a limit order book. The model contains an extended autoregressive conditional duration model with a flexible generalized Beta distribution to explain the duration process, combined with a dynamic logit model to capture the traders' order submission strategy. I find that the state of the order book as well as the speed of the order arrival have a significant influence on the order placement, inducing temporal asymmetric market movements.