A Tale of Three Cities: Is an Electronic Public Order Book Appropriate for Transition Economies?

Abstract

Computerized order-driven trading systems have proven highly successful in developed market economies with deep and liquid markets, but is an electronic public order book the best choice for a transition economy? We examine the experience of three newly created stock exchanges in the formerly planned economies of Poland, Lithuania, and Latvia, each of which adopted an electronic public order book developed in co-operation with the Paris Bourse. The exchanges in Warsaw, Vilnius, and Riga have followed a similar pattern of development from a single-price call auction once a week, to daily call auctions, to the introduction of continuous variable price trading using a public order book using state-of-the-art technologies. We find that only Warsaw has successfully concentrated liquidity in a single-price call auction, while in both Vilnius and Riga, the order books are largely empty for the majority of listed securities. An examination of trading by market segments reveals that Warsaw trades the bulk of its shares in the single-price call auction, block trades predominate in Vilnius, while continuous variable price trading accounts for most of the turnover in Riga. We observe sharply divergent results in both how shares are traded, as well as in the level of economic function achieved by the exchanges. Our findings suggest a set of necessary conditions in order for an order-driven trading system to succeed in a transition economy environment. Careful attention must be paid to listing requirements, price fluctuation limits and the minimum size of trades, the provision of liquidity, and tick size, so that the intended function of the electronic public order book is realized.