Price Discovery Efficiency Research Articles

The impact of trading floor closure on market efficiency: evidence from the Toronto Stock Exchange

On 23 April 1997, the Toronto Stock Exchange closed its trading floor, making it at that time the second-largest stock exchange in North America to choose a purely electronic trading environment for its equities. Exploiting this natural experiment, we find that the move to electronic trading resulted in a higher cost of immediacy (bid–ask spreads), increased information asymmetry and an overall deterioration of short-horizon return predictability from past order flows, reducing the efficiency of price discovery. Our results suggest that the human element plays an important role in order execution and complements automated electronic trading by improving the efficiency of incorporating new information into prices.

The Impact of Trading Floor Closure on Market Efficiency: Evidence from the Toronto Stock Exchange

On 23 April 1997, the Toronto Stock Exchange closed its trading floor, making it at that time the second-largest stock exchange in North America to choose a purely electronic trading environment for its equities. Exploiting this natural experiment, we find that the move to electronic trading resulted in a higher cost of immediacy (bid–ask spreads), increased information asymmetry and an overall deterioration of short-horizon return predictability from past order flows, reducing the efficiency of price discovery. Our results suggest that the human element plays an important role in order execution and complements automated electronic trading by improving the efficiency of incorporating new information into prices.

Price Evolution in a Continuous Double Auction Prediction Market With a Scoring-Rule Based Market Maker

The logarithmic market scoring rule (LMSR), the most common automated market making rule for prediction markets, is typically studied in the framework of dealer markets, where the market maker takes one side of every transaction. The continuous double auction (CDA) is a much more widely used microstructure for general financial markets in practice. In this paper, we study the properties of CDA prediction markets with zero-intelligence traders in which an LMSR-style market maker participates actively. We extend an existing idea of Robin Hanson for integrating LMSR with limit order books in order to provide a new, self-contained market making algorithm that does not need “special” access to the order book and can participate as another trader. We find that, as expected, the presence of the market maker leads to generally lower bid-ask spreads and higher trader surplus (or price improvement), but, surprisingly, does not necessarily improve price discovery and market efficiency; this latter effect is more pronounced when there is higher variability in trader beliefs.

Price Discovery and Market Efficiency of Commodities Futures Market in India- A Cointegration and Causality Analysis

The paper studies the Indian commodity futures market in order to determine the price discovery, long run market efficiency and short run dynamics in futures market using by time series analysis tools. To test the market efficiency and long run equilibrium, tools like Engle and Granger co-integration test (1987) and Johansen co-integration test (1988) have been applied. The Granger Causality (1969) test is used test the market efficiency to infer cause and affect relationship between spot and futures market in India. To examine efficiency of commodity futures and spot market the MCXs1 four spot and futures commodity indices data are used. The paper observes that the role of commodity futures is very significant in price discovery, and improving efficiency of the market.

Fragmentation and Price Discovery: A Comparison of Reg NMS and MiFID1

We study NYSE, NASDAQ, and ARCA prices for DJIA stocks and LSE, Xetra, and Chi-X prices for five leading British equities. MiFID1 hastened fragmentation but accomplished the intended cointegration of European equity markets that had previously been segmented. Initially, price discovery in London was largely unaffected; permanent quote innovations remained more than 90% attributable to the LSE. However, clearing and settlement fee reductions by Chi-X five months later did result in a substantial reduction in the information impounding and price discovery efficiency of London Stock Exchange trades. The contemporaneous situation in the United States with the implementation of Reg NMS was quite different. During its staggered rollout in 2007, NYSE’s price discovery declined steadily from 74% to 41%, with much of that role migrating to ARCA. In this case, the price discovery efficiency of NASDAQ substantially improved.

High-Frequency Trading and Price Discovery

We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs' liquidity supplying orders are adversely selected. The direction of HFTs' trading predicts price changes over short horizons measured in seconds. The direction of HFTs' trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.

Kospi 200 (Increase of Option Multiplier and Price Discovery in Kospi 200 Spot and Option Markets)

Korean Abstract: 본 연구는 KOSPI200 옵션의 거래승수 인상이 옵션시장의 가격발견기능에 미치는 영향을 분석한다. 풋-콜 패리티로부터 도출된 KOSPI200 내재지수와 현물지수로 구성된 벡터오차수정모형을 이용한 주요 분석결과는 다음과 같다. 첫째, 내재지수와 현물지수간 괴리도는 승수 인상 전에 비해 인상 후에 감소하여 가격형성의 효율성이 개선되었다. 둘째, 승수 인상 후 옵션시장으로부터 현물시장으로의 정보이전과 가격발견의 주도력이 강화되었다. 셋째, 인상 후 기간에 옵션시장이 가진 현물가격 발견의 주도력은 거래량이 높은 표본에서는 강하게 상승했지만, 거래량이 낮은 표본에서는 옵션가격이 현물가격 변동에 후행하는 경향을 보였다. 이러한 결과는 승수 인상으로 인한 유동성 위축에도 불구하고, 승수 인상 전까지 KOSPI200 옵션시장에서 가격발견의 효율성을 저해하는 요인으로 상당한 비중을 차지했던 투기적(노이즈) 거래가 인상 후에 급감한 결과 옵션시장의 현물가격 발견기능이 활성화된 것으로 해석할 수 있다. English Abstract: To mitigate the problems related to the excessive speculation and high participation of retail investors in the KOSPI 200 options market, the Financial Services Commission raised the option multiplier for KOSPI 200 options to KRW500,000 equal to five times prior multiplier since March 9, 2012. The implementation of new multiplier induced radical shrinkage of liquidity in KOSPI 200 options market. This paper examines the effect of the increase of option multiplier on the price discovery functions in KOSPI 200 spot and option markets. An implied KOSPI 200 index is derived from the put-call parity relationship for index options and VECM with KOSPI 200 spot and implied indexes is applied. The main results are summarized as follows: (1) the difference between the implied and spot index, which measures an arbitrage opportunity, was decreased during the period of new multiplier. This result means that the efficiency of price discovery in KOSPI 200 options market was enhanced after the increase of option multiplier. (2) The option market leads more strongly the spot market in the price discovery process during the period of new multiplier, (3) the dominant role of option market in the price discovery process is more strong in the high liquidity sample rather than the low liquidity sample, and (4) the convergence process of temporary put-call parity violations to the parity relationship is more activated during the new multiplier period, and the dominant role of option market is closely related with this convergence process. Overall the results show that increase of option multiplier positively contributes to the price discovery of KOSPI 200 options market even though sharp shrinkages in liquidity due to new multiplier.

International cross-listing and price discovery under trading concentration in the domestic market: Evidence from Japanese shares

This study examines the role for the Tokyo and the New York Stock Exchange in price discovery for Japanese shares. A structural approach is employed to investigate the efficiency and contribution in price discovery separately. We find that the speed of incorporating information into prices is faster in New York than in Tokyo. Three approaches are taken to control the size of information and confirm that New York is the efficient side in information assimilation. We also find that the observable liquidity measures such as trade frequency, bid–ask spread, volume per trade and return variance, explain the price discovery efficiency.

International Cross-Listing and Price Discovery under Trading Concentration in the Domestic Market: Evidence from Japanese Shares

This study examines the role for the Tokyo and the New York Stock Exchange in price discovery for Japanese shares. The two markets' trading hours do not overlap and the trading volume concentrates in Tokyo. State space model approach is employed to investigate the contribution and the efficiency of price discovery. We find that the size of information incorporated in prices observed at Tokyo is greater than in New York. More than 90% of the information is incorporated during the trading hours in the domestic market. In contrast the speed of incorporating information into prices is faster in New York than in Tokyo. New York takes less than half of what Tokyo takes to incorporate information. Our simulation suggests that the contribution on price discovery by New York Stock Exchange would be non-trivial if the two markets open simultaneously.

Efficiency of Price Discovery during Nighttime Trading Session : Evidence from KOSPI200 Global Futures

Trading of KOSPI 200 futures on CME Globex platform, which was launched in November 2009, starts at 18:00 and closes at 05:00 in the next morning. This paper examines how price of KOSPI200 Global futures is discovered during nighttime trading session by using tick data. The overall results of this study can be summarized as follows; First, we find that the weighted price contribution (WPC) exhibits asymmetric ‘W’-shaped curve during session. This finding is interpreted as that information is consequently transmitted from Globex and NYSE with ‘U’-shaped curve of intradaily price discovery to KOSPI 200 Global futures. Meanwhile, the weighted volume contribution (WVC) also shows ‘W’-shaped curve but weighted price contribution per volume contribution (WPCV) indicates asymmetric ‘U’-shaped curve. This finding that a trade is more (less) informative when trading intensity is higher (lower) provides evidence of partially supporting the “Event Uncertainty Hypothesis” over “Hot Potato Hypothesis”. Second, the price change of closing to opening time significantly contributes to price change during the close-to-close time span. This result explains information during regular daytime trading of KOSPI200 futures is efficiently incorporated in opening price of nighttime session. Third, nighttime traders of KOSPI200 futures recognize volatility of US stock market as more valuable information than the price of futures on CME Globex.

IPO price discovery efficiency under alternative regulatory constraints: Taiwan, Hong Kong and the U.S.

It has been proven by Ljungqvist and Wilhelm (2002) that constraints on underwriters' allocation discretion reduce price revisions. The dual-tranche bookbuilding in Taiwan and Hong Kong imposes more regulations limiting underwriters than U.S. bookbuilding does, but price revisions of Taiwan and Hong Kong IPOs are higher than those of the U.S. This is due not to increased information production but to the primary market inefficiency. Due to the endogenous heterogeneity of price revisions related to underpricing among countries, we use variance ratios to prove that the empirical evidence in Taiwan and Hong Kong is not contradictory to Ljungqvist and Wilhelm (2002).

High Frequency Trading and Price Discovery

We examine empirically the role of high-frequency traders (HFTs) in price discovery and price efficiency. Based on our methodology, we find overall that HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs' liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs' trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances. JEL Classification: G12

European Market Quality Pre-/Post-MiFID: A Panel Discussion of Metrics for Market Integrity and Efficiency

Academics and practitioners discuss the state of capital market integration in Europe and specifically, several metrics of market efficiency and market integrity pre and post-MiFID. Security market integrity is measurable, and higher integrity lowers spreads and price impact, improving market efficiency. European spreads were amongst the lowest in the world well before MiFID. After MiFID, market manipulation dislocating the close fell in London but rose in Paris. Cumulative abnormal profit from trading ahead of price sensitive announcements as a percentage of turnover remains half as great in Paris as in London. Trading on Chi-X ahead of price-sensitive announcements is lower than average for Europe which on this metric has the highest integrity on a regional basis worldwide. Xetra exhibits the highest overall market integrity amongst all European exchanges and MTFs, pre and post-MiFID. Price discovery efficiency in London and Paris has declined with the fragmentation of order flow post-MiFID. Keywords: Market quality, market integrity, manipulation, insider trading, price discovery

Price Discovery Efficiency and Permanent Information Impounding on Nyse Euronext Paris

Since European trading now traverses national boundaries, and MTFs are rampant, how have the stock price dynamics changed? Analysing the execution channels NYSE Euronext Paris, Chi-X and BATS in CAC40 stocks, we compare metrics of market efficiency pre/post-MiFID and provide insight into the price discovery implications of high frequency trading. Utilizing Hasbrouck’s Information Share and Gonzalo and Granger’s Common Factor Share in a unifying framework, we distinguish price discovery efficiency from permanent information impounding. Although the primary exchange NYSE Euronext Paris has lost only 10% of the information impounding to the MTFs, these alternative mechanism designs exhibit remarkably high price discovery efficiency.

High Frequency Trading and Price Discovery

We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances. (for internet appendix click: http://goo.gl/vyOEB)

Local investors, price discovery, and market efficiency

This study examines the effect of locally informed investors on market efficiency and stock prices using large power outages, which are exogenous events that constrain trading. Turnover in stocks headquartered in an outage area with 0.5% of U.S. electrical customers drops by 3–7% on the first full day of the outage, and bid–ask spreads narrow by 2.5%. Firm-specific price volatility is 2.3% lower on blackout dates. This effect is larger for smaller, lesser-known stocks and in higher income areas. Consistent with a valuation discount and higher expected returns for stocks with more informed traders, firms with a one-standard-deviation higher local trading propensity have market-to-book values that are 5% lower, Tobin's Q that is 6% lower, annualized four-factor alphas that are 1.2% higher, and average spreads that are 6.5% higher. Together, the evidence suggests that informed investors contribute disproportionately to both liquidity and price discovery, and that these contributions are reflected in valuations and expected returns.

Price Discovery and Market Efficiency Revisited: Anecdotes from Indian Pepper Futures Markets

We have taken pepper as a commodity to explore the co-integrating vectors, nature/direction of causality, and subsequently, we try to model volatility spillover in Indian pepper futures and spot markets employing Johansen‟s co-integration, VECM, Granger causality and variance decomposition tests. We draw inferences from the study that unidirectional causality has been observed in case of pepper futures market. However, the adjustment of innovations or shocks in futures market is relatively faster than that of spot markets. For volatility modelling, we have employed models with their specifications, namely, EGARCH (2,2), EGARCH (3,3), MGARCH (Diagonal VECH and BEKK) for both pepper‟s spot and futures return-series. Study reveals that unidirectional spillover has been identified under EGARCH (2, 2) model and results obtained through EGARCH (3,3) model are not impressive. News impact curve depicts the steeper movement on the logarithmic conditional variance of futures and spot-return series, which is due to positive shocks rather than that of negative shocks. Conditional correlation seems to be dynamic in nature and the correlation between spot and futures returns of pepper has been witnessed the temporal changes.

Price Discovery in Crude Oil Prices

I examine the relative information roles among West Texas Intermediate spot crude price and four futures contracts (F1 through F4) with different maturities. Using a cointegrated system with a non-unitary cointegrating vector, I address price discovery by investigating which price is more responsive to a common trend shock. With a non-unitary cointegrating vector, it is not clear on how to apply Hasbrouck (1995)'s Information Share (IS) and Yan and Zivot (2007)'s Price Discovery Efficiency Loss (PDEL) measures. I suggest a way to make the IS and PDEL applicable to non-unitary cointegrating vector. Also, I propose a new static price discovery measure, which I call the Adjustment Share (AS). The AS measures the amount of price discovery as the share of contemporaneous adjustment toward the long-run level to a one-unit common trend shock. Applying different price discovery measures to bivariate and 5-variable crude price models I find that F4 and F3 show dominance of price discovery over F2 and F1. If we consider price adjustment to the permanent shock only, F1 does not lead the spot price.

Relative Efficiency of Price Discovery on an Established New Market and the Main Board: Evidence from Korea

AbstractWe examine the relative efficiency of price discovery between the new market (KOSDAQ) and the main board (KOSPI) in the Korean stock markets that have the same trading mechanism (i.e. electronic limit‐order book), focusing on the comparisons of each market’s efficiency of price discovery in three aspects: speed, degree, and accuracy. We find that, for our entire firm sample, price discovery on KOSDAQ is less efficient than on KOSPI. However, the price discovery of the most liquid group (top 40 stocks) on KOSDAQ turns out to be as efficient as the lowest group (top 160th–200th stocks) among the top 200 liquid stocks on KOSPI. These two quintiles are comparable in terms of their firm characteristics, so it appears that the greater overall efficiency of price discovery on KOSPI is due to the characteristics of its listed firms, rather than any inherent difference between a main board and a new market. We also find evidence that the speed of price discovery is mainly determined by turnover, whereas the accuracy of price discovery is mainly determined by turnover and intraday volatility. All together, our results provide some policy implications for developing or even developed countries eager to establish a viable new market. First, price discovery in a successful or viable new market in an emerging economy behaves as predicted in the market microstructure literature, even though that literature is based primarily on main boards in advanced stock markets. Second, price discovery in the most liquid group in a new market is more accurate, although slower, than in the lowest group among the liquid stocks on a main board; on balance, the main board and new market are comparable. Finally, the accuracy of price discovery is more (less) impacted by turnover (intraday volatility) on the new market than on the main board.

Price Discovery, Competition and Market Mechanism Design

Based on the wide application of relevant classical and modern economic thoughts, this paper analyzed the implications of price discovery and competition, compared the market auto adjustment mechanism and the government control of economy, explored market failure and price distortion, and drew the conclusion of the necessity of market mechanism design which is especially helpful for the reform of transitional economies. We point out that market competition plays an important role in the process of price discovery. To promote the efficiency of price discovery, market competition can not be absent. But competition can not be the only solution to efficiency. Moderate government interference is needed in some circumstances. Optimal mechanisms should be designed to complement the incompleteness of competition.