Measures Of Market Quality Research Articles

Return and liquidity response to fraud and sec investigations

This study measures the long-run costs and benefits associated with fraud and securities enforcement actions by examining the changes in market quality of firms that are investigated by the Securities and Exchange Commission for fraud. The market quality measures we test include returns, price volatility, spreads, and illiquidity. We find a significant deterioration of market quality following the market’s discovery of the misconduct. We also find that during periods in which the SEC is actively investigating the firm daily returns and price volatility improves while spreads widen and liquidity declines. Our work highlights some of the benefits and costs of having an active regulator over US securities markets.

The effects of make and take fees in experimental markets

We conduct a series of experiments to examine the effects of the make and take fee structure currently used by equity exchanges in the U.S. We examine the effects of these fees on measures of market quality (efficiency, book depth, and the bid-ask spread). We find spreads to be smaller in the presence of make and take fees, and we note that this fee structure seems to induce buyers (moreso than sellers) to compete for rebates from the exchange leading to higher prices and lower profits. To test whether our results are due to the make and take fee structure or are artefacts of trading fees in general, we performed a second set of experiments in which traders on both sides of a transaction were assessed an identical fee. These identical trading fees do not appear to significantly affect our market quality measures.

Equity Trading Costs Have Fallen Less than Commonly Thought. Evidence Using Alternative Trading Cost Estimators

Equity markets are evolving rapidly. The technology of financial intermediation has changed from monopolistic (manual) market makers to multiple algorithms providing liquidity in competing order books, both visible and dark. Has this changed market quality? To answer this, we need measures of market quality (liquidity) invariant to technological innovation in intermediation. In particular, innovation has led to a huge drop in order sizes due to order splitting. Orders are spread out both in time and across exchanges. We use data from the US and Norway to show that the last two decades' marked fall in average spreads is driven by the decline in transaction sizes. Using alternative estimators of transaction costs less sensitive to trade size, such as the Corwin and Schultz (2012) and Abdi and Ranaldo (2017) high/low estimators, we show that equity market quality has improved less than commonly thought.

Trade-Time Measures of Liquidity

Dramatic microstructure changes in equity markets have made standard liquidity measures less accurate proxies for trading costs. We develop trade-time liquidity measures that reflect per-dollar price impacts of fixed-dollar volumes. Our measures better capture institutional trading costs and better explain the cross-section of returns than do standard measures, especially in recent years. Despite improvements in measures of market quality, expected trading costs have explanatory power for the cross-section of expected returns: we obtain monthly liquidity premium estimates of 5.3 bp for expected returns and 2.4 bp for risk-adjusted returns. Estimated premiums rise after the financial crisis and remain high thereafter.

The Effect of Exogenous Information on Voluntary Disclosure and Market Quality

We analyze a model in which information may be voluntarily disclosed by a firm and/or by a third party, e.g., financial analysts. Due to its strategic nature, corporate voluntary disclosure is qualitatively different from third-party disclosure. Greater analyst coverage crowds out (crowds in) corporate voluntary disclosure when analysts mostly discover information that is available (unavailable) to the firm. Nevertheless, greater analyst coverage always improves the overall quality of public information. We base this claim on two market quality measures: price efficiency, which is statistical in nature, and liquidity, which is derived in a trading stage that follows the disclosure stage.

How the Australian Ban on Short Selling During the GFC Affected Market Quality and Volatility

We examine the effects of the short selling ban, imposed by Australian regulators in the wake of the global financial crisis, on trading of financial stocks. Unlike other developed markets, where regulators imposed short-selling restrictions for brief periods of time at the height of the financial crisis, the ban on short selling of financial stocks on the Australian Stock Exchange lasted eight months, including both the tumultuous end of 2008 and the calmer period up to May 2009. Our control group consists of matched Canadian financial institutions which were unaffected by a short selling ban. We analyze the impact of the imposed short selling constraints on measures of market quality and on stock prices using univariate and multivariate fixed effects panel regressions. As predicted by previous theoretical work, we find that stocks subject to the short selling ban suffered a severe degradation in market quality. Controlling for the adverse effects of the financial crisis on financial markets, we show that imposing constraints on short-selling reduced trading activity, increased bid and ask spreads and increased intraday volatility. Moreover, there appears to be no evidence for lasting price support from the restrictions.

The Relationship between Listing Requirements and Market Quality: An Examination Using NASDAQ’s Tiered Market Structure

This study examines the relationship between listing requirements and market quality. Related studies analyzed market quality by focusing on disclosure requirements, while neglecting potential effects from listing requirements. Most of these studies failed to control for different market structures, thereby creating joint hypothesis problems. Using the unique structure of NASDAQ, We examine market quality while controlling for disclosure requirements and market structure. We find a significant relationship exists between listing requirements and four measures of market quality. The results indicate that listing requirements represent the types of information revealed, whereas disclosure requirements represent the mechanism through which markets reveal information.

U.S. Experience with Futures Transactions Taxes: Effects in a Highly Intermediated Market

The transactions tax on futures sharply reduced trading volume on wheat and corn contracts during the 1920s and 1930s but had no apparent effect on volatility or market quality. I find no evidence of a tax effect on open interest: I hypothesize this is because the relative magnitude of the tax was significantly higher for intermediaries than for other participants. Instead, the tax appears to have substantially reduced intra-day trading but not longer-term positioning. Volume-related proxies of liquidity therefore exhibit a strong relation with tax rates, but other measures of market quality show no relation to tax rates. In the long-run, however, exchange members doubled the minimum tick size in order to retain a large number of market makers and offset the impact of the tax.

Order imbalance and selling aggression under a shorting ban: Evidence from the UK

Order imbalance is one of the indicators used by traders to assess the excess of buy or sell orders for a security traded on an exchange. Order imbalance data are made transparent to market participants so as to enhance the quality of the opening and closing auction in the exchange. While order imbalance can result from escalating volatility of security prices, traders can protect themselves by using a limit instead of a market order. The order imbalance and other market quality measures are expected to worsen when a market is experiencing heavy shorting. Based on a high-frequency intraday dataset from the London Stock Exchange from September 2008 through April 2009, our findings suggest that the order imbalance rose after the ban on short selling was enacted in the UK stock market and that selling aggression as well as other market quality measures showed no evidence of any marked improvement.

High-Frequency Trading in Limit Order Markets: Equilibrium Impact and Regulation

We investigate the impact of high-frequency trading (HFT) on market quality and investor welfare using a general limit order book model. We find that while the presence of HFT always improves market quality under symmetric information, under asymmetric information this is the case only if competition between high-frequency traders is sufficiently strong. While HFT does not negatively impact investor welfare, it reduces the welfare of slow speculators. The flexibility of the model allows investigating the effect of the main recent regulatory initiatives designed to curb HFT on market quality and investor welfare. We consider time-in-force rules, cancellation fees, transaction taxes, rebate fee structures, and speed bumps. While some of these regulations lead to improvements in a number of market quality measures, this generally does not translate into higher welfare for long-term investors. Rather, the main effect of such regulations is to generate wealth transfers from high-frequency traders to slow speculators. These regulations therefore appear inadequate to enhance investor welfare in the presence of HFTs. Of the different measures, transaction taxes are the least harmful; while they reduce welfare roughly by the amount of the tax, they do not significantly worsen market quality. The common practice by exchanges of granting rebates to limit orders is detrimental to market quality and investor welfare, causing both higher effective spreads and longer execution times.

Related Securities and Equity Market Quality: The Case of CDS

AbstractWe document that equity markets become less liquid and equity prices become less efficient when markets for single-name credit default swap (CDS) contracts emerge. This finding is robust across a variety of market quality measures. We analyze the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS. These spillovers greatly outweigh the potentially positive effects associated with completing markets (e.g., CDS markets increase hedging opportunities) when firms and their equity markets are in “bad” states. In “good” states, we find some evidence that CDS markets can be beneficial.

The Impact of High-Frequency Trading on Volatility. Evidence from the Italian Market

The huge increase of HFT activity in recent years has posed the crucial question of whether it is beneficial for financial markets to both researchers and regulators. Recent academic research has studied the impact of HFT on different measures of market quality, such as liquidity, transaction costs, market integrity and efficiency, though the results are sometimes non conclusive. This study focuses on the impact of HFT on stock price volatility over the period 2011-2013 for a sample of 35 blue chips traded on Borsa Italiana. High frequency traders (HFTrs) are identified according to two methods. The first one, based on public information on the trading strategies of market participants, led us to identify 14 traders (so called ‘pure’ HFT firms). The second one includes the main investment banks active in the European markets, since they carry out some proprietary trading which could take the form of HFT (as stemming from the evidence reported in ESMA, 2014). These approaches allow the identification of a lower and upper bound for the actual share of HFT on total trading volume. Potential endogeneity of HFT is controlled through an instrumental variable approach, using as an instrument the introduction of a new trading platform that eased the HFT activity by decreasing the latency. Results show that an exogenous increase of HFT activity causes a statistically and economically significant increase in volatility. In details, an increase by one standard deviation of HFT activity carried out by ‘pure’ HFT firms raises volatility by an amount between 0.5 and 0.8 standard deviations. This means that, if HFT activity increases by 10 percentage points the annualized intraday volatility increases by an amount between 4 and 6 percentage points depending on the specification used. If we also take into account the activity carried out by investment banks the impact of an increase by 10 percentage points of HFT activity leads to an increase of annualized volatility by an amount between 3 and 5 percentage points. This paper adds to the existing literature by providing new empirical evidence from the Italian market. Furthermore, it contributes to the policy debate, which had recently led the European regulators to introduce new rules aimed at mitigating possible negative effects of HFT.

Equity Trading in the 21st Century: An Update

This paper updates our previous study, "Equity Trading in the 21st Century", which presented results about US equity market quality. Despite many complaints in the national media, various measures of market quality indicate that US markets continue to be very healthy. Trade transaction cost estimates have stayed low and market depth and execution speeds remained high. New findings that measure the total transaction cost of executing very large block orders indicate that improvements in market quality also have benefited large institutional traders. While still high, both the number of quotes per trade and per minute have declined substantially from their peaks in 2008. Intraday volatility is below the levels of the pre-electronic 1990s. Although market quality is quite good, it could be enhanced. We discuss some current concerns about maker/taker pricing, dark pools, high frequency trading, tick sizes, designated dealers, transaction taxes, IPOs, and market stability.

The Role of Pre-Existing Liquidity in Determining Pricing Efficiency and Liquidity Gains Following the Introduction of SETSmm

In this paper we examine the impact that the new trading system SETSmm had on market quality measures such as firm value, liquidity and pricing efficiency. This system was introduced for mid‐cap securities on the London Stock Exchange in 2003. We show that there is a small SETSmm return premium associated with the announcement that securities are to migrate to the new trading system. We find that migration to SETSmm also improves liquidity and pricing efficiency and these changes are related to the return premium. We also find that these gains are stronger for firms with high pre SETSmm liquidity and weaker for firms with low SETSmm liquidity.

The impact of Securities Transaction Tax on market quality: Evidence from France and Italy

FILIP SRAMKO Abstract: This paper analyzes two recent securities transaction tax (STT) implementations in France and Italy in order to identify the effects of STT on market quality. The effects are observed on panel data in four periods utilizing several trading activity and market quality measures. Difference-in-Differences are estimated using several control groups including German and Spanish equities. The results suggest significant decrease in trading activity and liquidity in French taxed stocks following the STT levy. The effect of STT on volatility is statistically insignificant across different control groups and estimation periods. The need to account for seasonal effects is also demonstrated. In Italian case, the results are inconclusive due to possible contamination by political events, but the evidence points to decrease in trading activity following the reform. The evidence regarding volatility and liquidity in Italian case is mixed.

Is High Frequency Trading Beneficial to Market Quality?

This report discusses how high frequency trading (HFT) has changed the dynamics of the market and whether traditional academic measures of market “quality” are relevant in the new world of electronic trading. Using existing measures of market quality, which were designed over 20 years ago, much of the academic literature suggests HFT is beneficial for market quality. However, a closer examination of HFT reveals that the results may not be so beneficial and that many of these metrics are no longer applicable. This paper presents new metrics for market “quality”, which suggests that with the growth in HFT the probability of institutions getting orders filled has fallen and the time required to achieve a fill has increased. Additionally HFT trades tend to supply liquidity on the thick side of the order book, where it is not needed.

Return and Liquidity Response to SEC Investigation Announcements

This study measures the impact government enforcement actions have on investor confidence by examining changes in market quality in the firms investigated by the Securities and Exchange Commission for fraud. The market quality measures we test include returns, price volatility, spreads, and Amihud’s (2002) illiquidity measure. We find that returns improve and price volatility reduces during an SEC investigation. However, spreads widen and illiquidity significantly increases after controlling for the known determinants of liquidity. Our work highlights some of the benefits and costs of having an active regulator of the US securities market.

'Market Quality' and Moral Hazard in Financial Market Design

Infrastructure matters. Markets are designed by market participants for the benefit of market participants and assessed measuring utility to market participants. The natural result is that market structure becomes a tool used by the most powerful market participants to extract rents from the ultimate users of markets – issuers and investors, in particular. Our measures of market quality do not detect this moral hazard and its fruits because these measures mainly ascertain quantitatively whether the machine itself runs smoothly and cheaply, not whether the machine performs the function that a legislator or a teacher of securities regulation might say it should, such as to allocate capital effectively within an economy by providing optimal opportunities to invest savings. This paper examines our current measures of market quality against the background of the significant interests and arising structural distortions that exist in the US indirect holding system for the transfer of securities and the fragmented ‘national market system’ on which high frequency traders can prey on traders less well armed to navigate the complex array of matching platforms that major broker-dealers have built, financed or purchased. The paper closes with a recommendation that market quality be assessed for social efficiency rather than merely by meeting quantitative measures of mercenary efficiency to its operators and immediate users.

Computerization of the Equity, Foreign Exchange, Derivatives, and Fixed‐Income Markets

AbstractWe survey empirical studies on the development and effects of increased computerization across equity, foreign exchange, derivatives, and fixed‐income markets. While the changes in the trading process due to computerization in less liquid markets such as the corporate bond market have been modest, there have been dramatic changes in certain derivatives markets, foreign exchange, and particularly in equity markets. In many instances, previous research has found positive effects of computerization on measures of market quality, but our survey highlights that human intermediation is still prominent and beneficial in certain areas.

Broker ID transparency and price impact of trades: evidence from the Korean Exchange

Purpose– The purpose of this paper is to examine the changes in the price impact of trades in the major Korean stock market following the introduction of disclosure to all traders of the top five brokers on the buy-side and the top five brokers on the sell-side of trades in real time for each stock in the KOSDAQ market.Design/methodology/approach– The paper uses several alternative metrics for the price impact of trades. The study applies estimation methodology that accounts for the potential endogeneity of other market quality proxies, which are used as control variables in price impact regressions, by utilizing two-stage-least-square methods with fixed effect specification.Findings– This study finds that the permanent price impact (information effect) of both buyer- and seller-initiated trades increases, which indicates that information is disseminated quicker in a transparent market. Uninformed trades have a larger permanent price impact than informed trades on both the buy and sell sides. The liquidity price effects are found to be mixed for buys and sells.Research limitations/implications– The study supports the current policy of the Korean Exchange to publicly display the five most active broker IDs on both the buy and sell sides, as it attracts both informed and liquidity traders, leading to faster price discovery in a more transparent market. However, a future study which analyzes the change in the market quality in both local markets would provide a complete picture of the effects of the policy.Originality/value– Earlier studies documenting the effect of broker ID disclosure on market quality used effective spreads, market depth or order book imbalance as market quality measures. This study contributes to the existing literature by examining the changes in direct measures of the private information effect and liquidity effect of trades in a stock market – the Korean Stock Exchange – when the other part of the exchange (the KOSDAQ stock market) shifts to public broker ID transparency at the same transparency level.