Market Structure
trading rules and trading systems used by market
- affects information asymmetry in market and who trades profitably
Trading Sessions
- Call: trades take place when market is called
- Continuous: arrange traders when market is open
Execution systems
- Quote-driven: dealers arrange trades with customers
- Order-driven: trades are arranged via order precedence rule and trade pricing rule
Brokered: help buyers and sellers find each other - Hybrid
Information Systems
- Information collection
- Order routing/presentation
Quote driven Markets
In pure quote markets, public traders cannot arrange trades among themselves
- dealers supply liquidity and quote bid/ask prices
- information asymmetry: dealers can choose who they trade with
- dealer profit comes from beta spread
Order-driven markets
All traders issue orders to the exchange
Trade without intermediation of dealer
Brokered markets
Trade initiators contacts broker who then finds counter parties
- do not observe liquidity
Item traded is somehow unique and when dealers are unwilling to hold inventories (illiquid)
Hybrid markets
Most common: dealer-specialist
- order-driven auction markets in which the specialist must provide liquidity under some circumstances
Information systems
bring info in/out of market
- info collection systems
- info distribution systems
- order routing systems
- order presentation systems
Order presentation systems
manage exchange of info about orders and present them for consideration
- open outcry auctions (oral auctions)
- board-based trading systems
- screen based trading systems
Order books
- manage and store info about standing orders:
- electronic or paper based
Hold extremely valuable info
- front running opportunities
- arbitrage
Traders need to leave standing limit orders in the order books for order-book matching to work
- some traders do not want to show their orders
Price steps
minimum price multiples for a security
- depends upon the market price of security
Transparency Markets
report complete information to the public quickly
- Ex ante: market quickly reports all quotes and orders to the public
- Ex post: market quickly reports all trades to the public
Order precedence rules
buy limit orders with higher prices and sell limit orders with lowest prices take precendence
Time precedence
Orders ranked by arrival times
Increase in tick size makes:
time precedence more important
Price priority rule properties:
- gives best economic outcome from trading
- total gains are maximised
- call/periodic markets use uniform pricing rule. one price
- most continuous order driven trading systems use discriminatory pricing rule - arrange trades continuously as they arrive. Price changes as orders arrive
- some continuous order driven trading systems use derivative pricing rule (i.e. crossing networks)
Uniform pricing rule
Used at market open, in many exchanges and after trading halts
All matched orders executed at same price
- maximises commission
- single clearing price may not be obvious
Discriminatory pricing rule
trade price is limit price of standing limit order
Derivative pricing rule
matching orders executed at prices determined elsewhere
Problems:
- price manipulation
- stale price
- well-informed traders
Centre Point
offers executed at the prevailing mid-point of the national best bid and offer
- will only execute against other orders in centre point
- uses derivative pricing rule
Four Principles Determining Price:
1. Maximum Volume
calculate cumulative quantities at each price and find maximum executable quantity (smaller of the cumulative buy and sell quantities at each price)
Four Principles Determining Price:
2. Minimum Surplus
minumum surplus volume at each price determined in 1. Surplus is the difference between the cumulative buy and sell quantity at each price
Four Principles Determining Price:
3. Market Pressure
whether market pressure of the potential auction prices exist on the buy or sell side
+ sign: buy side pressure
- sign: sell side pressure
Highest of these prices is the oprning price
