Continuous Double Auctions and Microstructure

Abstract

Chapter One focuses on the movement of quote prices and the role of asymmetric information. Standard methods of estimating the impact of order flow shocks are made inappropriate by the existence of runs in trade initiation, which are theoretically impossible. We find runs that exist in trade initiation persist even after accounting for standard explanations. The chapter modifies the methodology of (Huang and Stoll, 1997) to use runs in trade initiation to account for the phenomena and estimates effects using ASX data. Chapter Two introduces a new experimental environment in which the market is continuously shocked by new traders’ incentives. The new environment joins two branches of theory. Classical economic theory has prices determined by the preferences of agents, but says little about the price formation process. The second theory is derived from finance in which prices are determined by the order flow coming to the market, but there is no connection between order flow and preferences. We show that in such markets, two competing generalizations of the Walrasian equilibria exist corresponding to these competing literatures, each with an independent pull on market prices. Prices and efficiencies reveal a strong roll of expectations in price discovery and reject the idea that convergence is due to random or zero-intelligence trading strategies alone. Chapter Three continues the analysis of Chapter Two by asking how the process of equilibration occurs in random arrival markets. We find that prices move proportional to the distance to the temporal equilibrium and show that this model’s predictive power is due to Marshallian features of the trading process as opposed the classical Walrasian adjustment model. Chapter Four studies an RA environment in which some traders have asymmetric information regarding the distribution of latent incentives and arrival rates. We find that much of insiders’ information is diffused as theory suggests and that much of the information is incorporated in outsiders’ market actions. This diffusion of information is not a result of cumulative signed order flow, but is instead related to the observable rate of aggregate speculation. The ultimate implications of this phenomenon remain unknown.