Pricing behavior in an off-hours computerized market

Automated markets are becoming increasingly widespread, and their efficiency properties are of corresponding concern to regulators and exchange policy makers. Many systems are implemented in settings characterized by a distinct lack of liquidity, however, often by design. We evaluate the performance of such a market, the GLOBEX overnight trading system, in absolute terms and relative to a liquid benchmark, the floor market of the Chicago Mercantile Exchange (CME). Our results with respect to bid–ask spreads and adverse selection suggest that the nature of the environment is an important determinant of market performance, but that an automated market can operate well in a relatively illiquid setting. Price clustering, indicative of a lack of pricing efficiency, is prevalent on the automated system, but price resolution improves as trading frequency increases.     

Informed trading and order type

Each trader must choose between a limit order, a market order, or using a floor broker. We hypothesize that informed investors will: (1) concentrate their trading in floor broker orders and (2) sometimes trade patiently. Consistent with our hypotheses, empirical results suggest that most informed trading occurs through orders executed by floor brokers and that informed floor brokers are sometimes patient. Regardless of their patience, however, quote revisions following trade executions are consistent with the hypothesis that markets recognize that floor traders are more likely to be informed than other traders. As a result, informed trading moves equilibrium security values.     

Automated Versus Floor Trading: An Analysis of Execution Costs on the Paris and New York Exchanges

A global trend towards automated trading systems raises the important question of whether execution costs are, in fact, lower than on trading floors. This paper compares the trade execution costs of similar stocks in an automated trading structure (Paris Bourse) and a floor-based trading structure (NYSE). Results indicate that execution costs are higher in Paris than in New York after controlling for differences in adverse selection, relative tick size, and economic attributes across samples. These results suggest that the present form of the automated trading system may not be able to fully replicate the benefits of human intermediation on a trading floor.     

Insights from bitcoin trading

We examine commonality in returns and volume for Bitcoin–fiat currency pairs, each trading in a country with a single time zone. Bitcoin has substantial volume and obeys the theory related to commonality, liquidity, and price discovery. We find evidence that one common factor explains 68% of the variance in hourly volume. Though trading is higher on weekdays, there is substantial weekend trading, reflecting high retail participation. Volume is higher on exchanges during local working hours, as seen in forex markets, supporting the view that trading patterns depend on the location of trade rather than the location of the asset traded.     

Information diffusion in electronic and floor trading

The attractiveness of floor trading versus anonymous electronic trading systems for traders is analysed. We hypothesize that in times of low information intensity, the insight into the order book of the electronic trading system provides more valuable information than floor trading, but in times of high information intensity, this is not true. Thus, the electronic system's market share in trading volume should decline when information intensity increases. This hypothesis is tested by DTB and LIFFE data on Bund-Future trading in the period 1991 to 1995. In the first years of trading, the DTB's market share is inversely related to price volatility and trading volume as proxies for information intensity. In recent years, this relation fades away; this can be explained by the high frequency of transactions which implies a steady flow of information on transactions.     

The trades of NYSE floor brokers

This paper studies the contribution of NYSE floor brokers to the Exchange's agency auction market. Floor brokers represent 44%, specialists 11%, and system orders 45% of the value of all executed orders in our sample. We analyze how the cross-sectional distribution of floor broker trading depends on liquidity, block volume, on- and off-exchange competition, volatility, and order flow internalization. Floor brokers participate in large trades, primarily in liquid stocks, and they trade more when volatility is high. They provide two-sided liquidity to the market and often provide liquidity that would otherwise have been supplied by NYSE specialists.     

The effect of sequential information releases on trading volume and price behaviour

This paper examines a two-period setting in which each trader receives a private signal, possibly different, in each period before he trades. The principal objectives are threefold. First, we describe the risky asset demands and price reactions in a noisy rational expectations equilibrium where the time 1 average private signal is not revealed by the price sequence but the time 2 average private signal is. Secondly, we analyse how informed trading volume is affected by the revealed information and supply shocks when pure noise trading volume is uncorrected with observable market variables. Our result indicates that no trade occurs for informed traders when net supply remains fixed across rounds of trade. And, when supply shocks are random, trading volume is induced by the informed and the noise traders, but noise trading is not predictable. Finally, we investigate these properties in the case when pure noise trading volume is correlated with observable market variables. It is shown that no informed trading takes place when there is no supply shock. However, when net supply contains random shocks, trading volume consists of noise and informed trading, both of which can be estimated.     

Continuous Trading or Call Auctions: Revealed Preferences of Investors at the Tel Aviv Stock Exchange

We use the move of Israeli stocks from call auction trading to continuous trading to show that investors have a preference for stocks that trade continuously. When large stocks move from call auction to continuous trading, the small stocks that still trade by call auction experience a significant loss in volume relative to the overall market volume. As small stocks move to continuous trading, they experience an increase in volume and positive abnormal returns because of the associated increase in liquidity. Overall, though, a move to continuous trading increases the volume of large stocks relative to small stocks.     

Prospect theory and a manager's decision to trade a blind principal bid basket

We analyze asset managers' decisions to execute substantial baskets of stocks. Such transactions can be executed in two ways. The first method is through blind auctions with unique features known as blind principal bids (BPBs). The manager learns the trading cost once the auction process determines the commission. The second method is to use an agency trade. In this case, the asset manager faces an actual trading cost that is unknown before execution due to market impact uncertainty. Using proprietary data, we investigate the manager's choice between BPBs and agency trade in a natural experiment with large monetary stakes. The volume traded in each sample basket is significant, which can amount to over 0.5% of the NYSE daily share volume. Our findings show that managers' behavior is more consistent with prospect theory than the expected utility framework. When asset managers trade BPB baskets, they are reluctant to realize the potential higher cost of agency trade and opt for the fixed cost of BPBs instead. Thus, our results complement the literature on the disposition effect by demonstrating that managers' trading cost decisions exhibit “play it safe” behavior.     

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 impact of tick size on intraday stock price behavior: evidence from the Taiwan Stock Exchange

This research examines the impact of tick size on intraday stock price behavior for stocks listed on the Taiwan Stock Exchange over the 2-year period of 1998–1999. The sample involves the same 80 firms that trade under the tick size of (New Taiwan Dollars) NT$0.1 and NT$0.5, respectively. The sample firms display a U-shaped intraday pattern of bid–ask spread, volatility, autocorrelation, and trading volume. The empirical results indicate that a larger tick size is associated with a wider bid–ask spread, larger volatility, and more negative autocorrelation. Moreover, a larger tick size is associated with a higher percentage increase of bid–ask spread and volatility in the middle of the trading period. Finally, the effect of tick size on trading volume is insignificant.     

Trading frequency and the efficiency of price discovery in a non-dealer market

The increasing popularity of non-dealer security markets that offer automated, computer-based, continuous trading reflects a presumption that institutionally-set trading sessions are economically obsolete. This theoretical paper investigates the effect of the trading frequency, a key feature of the trading mechanism, on the efficiency of price discovery in a non-dealer market. By tracing the market pricing error to the correlation structures of arriving information and pricing errors of individual traders, the effect of diverging expectations on error-based and overall return volatility is isolated. The analysis reveals that, due to a portfolio effect, an increase in the trading time interval has contradictory effects on the portion of return volatility stemming from pricing errors. The greater accumulation of information increases error-based return volatility, but the greater volume and number of traders per session have the opposite effect. The net effect on overall return volatility can go either way. It is found that the return volatility of heavily traded securities is likely to be minimized under continuous trading, but that of thinly traded securities may be minimized under discrete trading at moderate time intervals. The latter is more likely to occur the greater is the divergence of expectations among traders. These findings challenge the presumption that automated continuous trading in a non-dealer market is more efficient than discrete trading for all securities, regardless of trading volume. The findings are applicable to all economies, but have special importance for developing countries where typically a single market is dominated by small issues and a low volume of trade. As a by-product of the analysis, it is shown how to correct the biased estimate of inter-session price volatility when observations are less frequent than the trading sessions themselves.     

Impact of warrant introductions on the behaviour of underlying stocks: Australian evidence

The present study examines the impact of first‐time introduction of warrants by third party issuers on the trading behaviour of a sample of underlying stocks listed on the Australian Stock Exchange. We investigate the price, liquidity and volatility impact of underlying stocks after warrant issuance and find considerable differences to those found for option listings. Significant negative abnormal returns on both the announcement and listing date of derivative warrants are reported, followed by a negative price drift. Relative trading volume and price volatility of underlying stocks are found to be significantly higher post‐warrant listing. Interestingly, we find that warrant holders are unable to realize gains for the majority of trading days when they are alive, consistent with the view that banks trade profitability from their issue.     

A simulation analysis of the microstructure of an order driven financial market with multiple securities and portfolio choices

In this paper we propose an artificial market where multiple risky assets are exchanged. Agents are constrained by the availability of resources and trade to adjust their portfolio according to an exogenously given target portfolio. We model the trading mechanism as a continuous auction order-driven market. Agents are heterogeneous in terms of desired target portfolio allocations, but they are homogeneous in terms of trading strategies. We investigate the role played by the trading mechanism in affecting the dynamics of prices, trading volume and volatility. We show that the institutional setting of a double auction market is sufficient to generate a non-normal distribution of price changes and temporal patterns that resemble those observed in real markets. Moreover, we highlight the role played by the interaction between individual wealth constraints and the market frictions associated with a double auction system to determine the negative asymmetry of the stock returns distribution.     

Trading and Liquidity on the Tokyo Stock Exchange: A Bird's Eye View

The trading mechanism for equities on the Tokyo Stock Exchange (TSE) stands in sharp contrast to the primary mechanisms used to trade stocks in the United States. In the United States, exchange-designated specialists have affirmative obligations to provide continuous liquidity to the market. Specialists offer simultaneous and tight quotes to both buy and sell and supply sufficient liquidity to limit the magnitude of price changes between consecutive transactions. In contradistinction, the TSE has no exchange-designated liquidity suppliers. Instead, liquidity is provided through a public limit order book, and liquidity is organized through restrictions on maximum price changes between trades that serve to slow down trading. In this article, we examine the efficacy of the TSE's trading mechanisms at providing liquidity. Our analysis is based on a complete record of transactions and best-bid and best-offer quotes for most stocks in the First Section of the TSE over a period of 26 months. We study the size of the bid-ask spread and its cross-sectional and intertemporal stability; intertemporal patterns in returns, volatility, volume, trade size, and the frequency of trades; and market depth based on the response of quotes to trades and the frequency of trading halts and warning quotes.     

TRADE SIZE AND INFORMED TRADING: WHICH TRADES ARE “BIG”?

We find adverse‐selection spread components increase sharply in the ratio of trade size to quoted depth, and spike when trade size equals quoted depth. We find that two previously documented and prominent indicators of informed trading, raw trade size and high‐trading volume half‐hours, offer almost no explanatory power for informed trading measures beyond trade size to quoted depth, and a third indicator, time of day, offers no explanatory power among trades with high trade size to quoted depth. Our results suggest trade size to quoted depth is perhaps the single most important indicator that a trade is informed.     

Information asymmetry in warrants and their underlying stocks on the stock exchange of Thailand

This paper examines the informational role of warrants based on the unique order data from the Stock Exchange of Thailand, where both warrants and stocks are traded under the same market structure and where warrants are as liquid as stocks. The estimated probability of informed trading (PIN) in warrants is found to be statistically higher than their underlying stocks regardless of order submission type and order size. The PIN explains a substantial portion of the cross-sectional variation in the opening spread beyond trading volume and minimum tick size. We find evidence that a signed warrant trade contains information about the future stock price and that warrants with a higher PIN have greater predictive powers.     

Estimating the Probability of Informed Trading

Using a new empirical model, I estimate the probability of trades being generated by privately informed traders. Inference is drawn on a trade‐by‐trade basis using data samples from the New York Stock Exchange (NYSE). The modeling setup facilitates in‐depth analysis of the estimated probability of informed trading at the intraday level and for stocks with different levels of trading activity. The most important empirical results are: (a) the intradaily pattern of the inferred probability of informed trading is highly correlated with the intradaily pattern of observed quoted spreads, (b) differences in the magnitude of quoted spreads across volume categories are not exclusively related to differences in the level of informed trading, and (c) private information is incorporated faster in the quotes for high‐volume stocks than in the quotes for low‐volume stocks.     

The interaction between opening call auctions and ongoing trade: Evidence from the NYSE

We investigate the impact that the opening batch has on trading for the remainder of the day and what impact the prior day's trading has on the subsequent day's open. Traders have an interest in these trading impacts as their trades may cluster around opening and closing time periods. We find that the larger the volume in the opening batches, the greater the volume across the day. We also find the prior day's volume being positively related to the subsequent day's opening volume. Combined, these results suggest a continuing pattern of trade volume rolling from one day to the next. Additionally, we find that the spread in the continuous market can be partially attributed to the price change in the opening batch. We also find evidence of opening trade price reversals. Combined with the absence of price reversals following the opening trade, we conclude that the opening process may be more efficient at handling information than the continuous market.     

NYSE execution quality subsequent to migration to hybrid

In October 2006, the NYSE began rolling-out phase three of a four-phase plan initiate its new Hybrid trading mechanism. The results show that this new trading platform introduced a much larger proportion of electronic transactions relative to floor auction transactions. This migration to electronic transactions is further evidenced by a mirror shift in price discovery from floor trades to trades marked for automatic electronic execution. In addition, the move to Hybrid trading introduced a significant decrease in inventory control costs, as well as a noticeable increase in trade persistence. Finally, the new trading platform has increased the speed with which orders are met, and has also decreased the proportion of executed shares which receive price improvement.