Hybrid markets, tick size and investor trading costs

This paper shows how the tick size affects equilibrium outcomes in a hybrid stock market such as the NYSE that features both a specialist and a limit order book. Reducing the tick size facilitates the specialist's ability to step ahead of the limit order book, resulting in a reduction in the cumulative depth of the limit order book at prices above the minimum tick. If market demand is price-sensitive, and there are costs of limit order submission, the limit order book can be destroyed by tick sizes that are either too small or too large. We show that trading cost is minimized at larger tick sizes for larger market orders, creating an incentive to submit smaller orders when tick size is reduced. With a smaller tick size, specialist participation increases and specialist profit increases slightly for small market orders, and considerably for large market orders.     

The dynamics of individual and institutional trading on the Shanghai Stock Exchange

We investigate the daily dynamic relation between returns and institutional and individual trades in the emerging Chinese stock market. Consistent with the hypotheses of trend-chasing and attention-grabbing trading, we find that the response of individual trading to return shocks is much stronger than that of institutional trading, and individuals are net buyers following return shocks. Second, we find that past individual buys and sells have predictive power, whereas past institutional buys and sells have predictive power for market returns in longer horizons. However, both institutional and individual trading activities are more strongly related to past trades than past returns, and individual trading is also influenced by institutional trading. Moreover, we find that institutional trading in the largest quintile leads the trading in the smallest quintile, but no such lead–lag relation is found for individual trades. Finally, we find that the average cumulative abnormal trading volume of individuals is much larger than that of institutions around the firms' earnings announcement, suggesting that less-informed individual investors are more heavily influenced by firm-specific information disclosures and attention-grabbing events.     

On the distribution and estimation of trading costs

This paper investigates the uncertainty about the trading costs associated with a given portfolio strategy. I derive accurate approximations of the ex ante probability distributions of proportional trading costs and portfolio turnover under the conventional assumption of normal asset returns. Based on these approximations, I express the expected trading costs as a function of asset and portfolio characteristics. All else equal, the expected trading costs increase with: i) the deviations of the expected asset returns from the expected portfolio return, ii) the assets' volatility and iii) the portfolio volatility. At the same time, they decrease with the covariance between the assets and the portfolio. Furthermore, I propose novel estimators of the expected turnover and trading costs and show that they offer small bias and low variance, even when the sample size is small. Finally, I incorporate my results into a portfolio selection framework to produce portfolios with low levels of risk and trading costs. Several experiments with real and simulated data confirm the practical value of the results.     

The implications of liquidity and order flows for neoclassical finance

While liquidity and order flows are microstructure constructs, we show that they have profound implications for all of finance. In particular, liquidity is intimately connected with the fundamental building blocks of finance, namely, the pricing of risk, the powerful no-arbitrage theorems, and market efficiency. Large-sample studies of liquidity show that both liquidity and liquidity risk are priced in the cross-section of stock returns, the law of one price is more likely to hold in more liquid markets, and liquidity enhances market efficiency. Hence policies to enhance liquidity encourage efficiency and reduce costs of raising capital. Furthermore, order flows are powerful predictors of returns as well as the real economy.     

Trading costs for listed options: The implications for market efficiency

This paper reexamines the anomalous evidence concerning the efficiency of the listed options exchanges. We focus on the structure of trading costs in that market, and note several costs which generally have been ignored, the largest of which is the bid-ask spread. When we adjust the published trading rules for our estimates of these trading costs, the reported abnormal returns are eliminated.     

The growth in equity market size and trading activity: An international study

This paper presents new evidence on the role of macroeconomic and institutional factors in equity market development and on the sources of equity market growth. Using panel data on 33 countries, I find that development of financial intermediaries and trade openness are positively associated with equity market size, and that development of financial intermediaries is also positively associated with the level of activity in equity markets. Government consumption is negatively associated with equity market activity. I construct a direct estimate of the effect of institutional factors on equity market development that compares a country's actual level of development to a hypothetical “best-practice” country having the same macroeconomic fundamentals as the original country. I show that the level of equity market development of an average country is around 30% below its maximum potential. There are wide differences in institutional characteristics across countries and over time, and Canada, the United States, and Singapore possess the most shareholder-friendly institutional frameworks that foster larger and more active equity markets. It appears that institutional improvements and changes in financial technology have provided the major impetus for the phenomenal expansion of global equity markets.     

Determinants of bid and ask quotes and implications for the cost of trading

Financial transaction costs are time varying. This paper proposes a model that relates transaction cost to characteristics of order flow. We obtain qualitatively consistent model results for different stocks and across different time periods. We find that an unusual excess of buyers (sellers) relative to sellers (buyers) tends to increase the ask (bid) price. Hence, the ask and bid components of spread change asymmetrically about the efficient price. For a fixed order imbalance surprise these effects are muted when unanticipated total volume is high. Unexpected high volatility in the transaction price process tends to widen the spread symmetrically about the efficient price. Our findings are consistent with predications from market microstructure theory that the cost of market making should depend on both the risk of trading with better-informed traders and inventory risk. We also find that order flow surprises have a significant impact on the efficient price and can also explain a substantial amount of persistence in the volatility of the efficient price. This dependence does not violate the efficient market hypothesis since the surprises, by definition, are not predictable.     

The trading behavior of foreign,domestic institutional,and domestic individual investors: Evidence from the Taiwan stock market

In this paper, we apply the threshold cointegration model of Hansen and Seo (2002), incorporating differences in the nonlinear behavior of investors across regimes. An examination of the trading behavior of foreign, domestic institutional, and domestic individual investors in Taiwan revealed no predominance among the three types of investors. When the market was near equilibrium, the purchases of domestic individual investors positively impacted stock prices. This finding, which is consistent with Choe et al. (2005), suggests that domestic individual investors have an edge in investment performance over other types of investors. However, when the market departed substantially from equilibrium, the purchases of foreign and domestic institutional investors predicted a rise in stock prices. On the other hand, domestic individuals traded at worse stock prices; these prices tended to fall (rise) after the purchase (sale).     

Order preferencing, adverse-selection costs, and the probability of information-based trading

Although prior studies offer various conjectures on the causes and consequences of order preferencing, there is only limited empirical evidence. In this study, we show that the extent of order preferencing is significantly and negatively related to both the adverse-selection component of the spread and the probability of information-based trading. This result is consistent with the prediction of the clientele-pricing hypothesis that dealers (brokers) selectively purchase (internalize) orders based on information content. Our results suggest that order preferencing may not be as harmful as some researchers have suggested and offer some rationale for its prevalence in securities markets with heterogeneously informed traders. JEL Classification G18 · G19     

Structural decomposition of time series with implications in economics,accounting, and finance research

Recent literature on the decomposition of a time series into components has produced several alternative methodologies. This situation has arisen because of a lack of consensus on how components should be defined, and on the appropriate decomposition structure. Uncertainty about components structure seems to be inevitable when it is accepted that the behavior of a typical business or economic time series implies evolving rather than fixed components patterns. None of the existing procedures can be viewed as uniquely appropriate for the isolation of unobserved components.     

The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks

Considerable evidence from many countries suggests momentum strategies generate profits. These have been difficult to rationalise and evidence on the sources of such profitability is inconclusive. We utilise a sample of optioned stocks, characterised by high liquidity, high market capitalisation and fewer short sales constraints and compare results with control samples of non optioned stocks chosen on the basis of market value, turnover and bid–ask spread. The sample characteristics, and the fact that derivatives improve the impounding of information into prices, enable us to draw conclusions about the causes of momentum profits. While we find that short sales constraints are not the major driver of profitability and that most momentum profits disappear using two transactions costs measures of the bid–ask spread, one not previously used, the persistence of some momentum profits indicates that the market underreacts even to the most publicly available information.     

On measuring serial correlation: Implications for finance and accounting research studies

Accounting and finance studies that measure serial correlation implicitly make two assumptions. One, the studies assume that the sample estimate of the autocorrelation coefficient is unbiased. The assumption is intuitively appealing, but incorrect. This article provides a measure of the size of the bias. Two, the studies assume that the target of the time series is constant over time. However, over a long period target values may change. This article models the general case in which not only do random shocks affect actual values, but also random changes affect target values.     

The optimal trading and pricing of securities with asymmetric capital gains taxes and transaction costs

This article explores the optimal trading and pricing of taxablesecurities with asymmetric capital gains taxes and transactioncosts. In the long-term region, investors realize all gainsbelow some critical cutoff level, which we derive analytically.In the short-term region, investors defer all gains and, dependingupon the time remaining in the short-term region, may also defersmall losses. Contrary to common intuition, deferral of short-termlosses can be optimal even without transaction costs. The valueof tax timing is considerably higher under the optimal tradingstrategy than under alternative strategies previously analyzed.The impact of offset rules is also explored.     

The implications of e-commerce for strategy: UK case studies

In this paper, four case studies of retail financial services companies involved in Internet marketing of their services are investigated. The approaches taken range from a fully integrated approach, a stand-alone approach separate from the mainstream of the company's business, an experimental approach and an approach that can only be described as ‘reluctant’. The cases demonstrate the critical role of senior management, the possible limitations of market intelligence as a guide to action, the need to focus on resources and capabilities, and the requirement for creativity in strategy.     

The Era of finance: Proposals for the future

Finance, the economic activity intermediating between savings and investments, is probably the first to reach the stage of globalization; as a consequence, the financial sector is taking a leading position in modern economic systems. While the world expects from financial efficiency an increasingly positive contribution to welfare, it appears that recent developments of financial leadership in an increasingly deregulated world system, are also acting negatively on world welfare. In many aspects, it can be established that finance is crisis prone, induces deflationary biases and stimulates speculative behaviour: crisis, deflation and speculation are often harmful to the real economy. A set of proposals are made in order to improve world financial stabilization, promote growth and encourage the spirit of enterprise, as a way of enhancing the future contribution of financial activities to world welfare.     

Costly information production and optimal capital structuring: Theory and implications for finance and accounting

By considering a broad class of securities offerings that we termcapital structurings, a firm can always avoid pooling with firms whose prospects are poorer. This result implies that firms need not indulge in costly information gathering, hoping thereafter to signal to investors. One application allows us to describe a new theory of capital structurings, in which firms choose their capital structure not (as in traditional capital structure signaling theory) to signal privately known prospects, but rather to signal that no (productively useless) investigation of prospects has been pursued. A second application addresses the issue of the impossibility of informationally efficient capital markets: firms are capable of establishing conditions under which investors will recognize informational efficiency. The authors wish to acknowledge helpful comments by participants in seminars at the University of Hawaii at Manoa and the Univeristy of Tsukuba. Particular thanks go to Adam Brandenburger and an anonymous referee. Naturally, any remaining errors are the responsiblity of the authors. C.J.J. is on leave at the Council of Economic Advisers. This article reflects the opinions of the authors and not that of the Council of Economic Advisers. Much of the work for this article was conducted while E.H.R. was on leave at the Institute of Socio-Economic Planning at the University of Tsukuba, Tsukuba, Ibaraki 305, Japan.     

Privatization,coordination and agency costs: The case for participation in Eastern Europe

In the paper, the interdependency between privatization and the growth of a new private sector is examined. While the dismantling of the omnipotent economic role of the state is a sine qua non for massive private investment, a vigorous private sector is needed to reduce unemployment and thus make further privatization possible. Since privatization is a lengthy process associated with a medium-term goal, while getting private investment started is important at the very beginning of the transition, this linkage constitutes a serious dilemma for the transformation. Multiple expectational equilibria arise and appropriate beliefs are crucial for the success of the reforms. Voucher schemes are shown to reduce agency costs of private investment and in this way may help to ensure coordination on the optimistic equilibrium.     

Measuring the costs and benefits of regulation: Conceptual issues in securities markets

This paper reviews the economic theory of regulation and surveys the empirical evidence on its application to past and recent changes in U.S. securities regulation. The theory provides multiple potential motives for regulation and cautions the empirical researcher against naïve modeling of the costs and benefits of regulatory change. Moreover, the nature of the regulatory process compounds the standard pitfalls of empirical analysis such as endogeneity and confounding events. Productive empirical techniques include the development of cross-sectional predictions of the effects of regulation as well as the use of unregulated control samples. An important avenue for future research is a more refined estimation of the extent to which regulation has unintended consequences.     

金融监管体系演进与发展趋势问题研究——基于金融危机视角

从金融危机的视角看,金融监管体系演进与发展和金融危机密切相关.监管当局为了维护金融体系的安全与稳定,降低金融危机的影响与危害,避免金融危机的再次发生,总是不断寻找新的监管重点、变革监管范围和手段.来保持金融监管的有效性.本文从三代金融危机导致金融体系不稳定的因素存在差异出发,阐述金融监管体系变革的过程和发展趋势,并得出了几点启示.